Uncovered: What are corporate bonds?
Demand for many investments has suffered in the wake of the financial crisis. Investors, wary after suffering two big bear markets in just over a decade, are putting less money into shares. Property continues to fascinate, but sales are down compared to the pre-crisis days. But one asset class has seen interest boom among private investors. We're talking about corporate bonds. Read on to find out what corporate bonds are...
Companies are taking full advantage of an increase in demand, Phil Oakley in MoneyWeek
It seems that almost every week, another company launches a new bond for investors to buy.
So today let's look at how corporate bonds work.
Why do companies issue bonds?
All businesses need money to fund themselves. This can come from the owners of the business (shareholders) in the form of equity, or it can be borrowed.
Lots of companies borrow money from banks, just as we might do if we wanted to buy a house or a car. But there is another option open to them as well.
Companies can also borrow money from investors. They do this by issuing bonds that can be traded on the stock exchange. Because these bonds are issued by companies, they are called corporate bonds. (Governments borrow money this way too).
Say a company wants to borrow R100 million. What it will typically do is divide this amount into individual bonds – IOUs basically – of R100, which investors can then buy. It will offer to pay a rate of interest – say 6% – on these bonds, every year for the next ten years. At the end of the period, it will pay the R100 back.
So there you have it, what corporate bonds are.