When a corporation needs to find extra money, one of the ways they
raise funds is through selling bonds. You are basically loaning the
company money when you purchase a corporate bond.
This is the
riskiest form of fixed-income securities. They are only backed by the
individual corporation who may be likely to suffer from serious
financial problems. But you will be compensated for the risk. Corporate
bonds pay a higher interest rate than is paid on most government
securities.
You interest rate is called the coupon. By holding
the bond until maturity, you receive the full face value of the bond -
if the company doesn't default. If you well before the maturity date,
you may lose some of the principal if interest rates have risen.
Bond
prices fall when interest rates rise. They rise when interest rates
fall. For example, you buy a 10-year bond with a face value of $5,000
and a coupon of 6%. After three years you decide to sell your bond.
Interest rates have risen to 8%, making your bond worth less because a
new bond will pay more than your old one. But if you are receiving
higher rates than newly purchased bonds, you will get a premium for it.
There
are two agencies, Standard & Poor's and Moody's, which assign
credit ratings to corporate bonds. The rating is based on the company's
ability to repay its debts.
The poorer the rating, the higher the
risk. And the more interest you will receive. You are being paid to
accept the risk that the company might default and you will lose your
money. Even the most well known companies can have problems. For
example, Ford Motor Company bonds were once rated at near junk status.
Investors were paid high interest rates for their investment. This is a
very risky investment. If you are a new investor, you should probably
stick with lesser risk bonds.
Corporate bonds are purchased
through a broker or by visiting the company's website for contact
information. The best way for most individuals to buy corporate bonds
is through a bond fund. Bond funds give you exposure to a wide variety
of companies, therefore reducing the risk. Check with a fund rating
company to research the fund's performance.
With bond funds there
is no guaranteed return of the principal. While each bond has a
maturity date, the fund does not. You will have to sell your shares to
exit the fund.
Martin Lukac (http://www.MartinLukac.com), represents http://www.RateEmpire.com and http://www.1AmericanFinancial.com,
a finance web-company specializing in real estate/mortgage market. We
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