Corporate bond

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A corporate bond is a bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, mergers & acquisitions, or to expand business.[1] It is a longer-term debt instrument indicating that a corporation has borrowed a certain amount of money and promises to repay it in the future under specific terms.[2] Corporate debt instruments with maturity shorter than one year are referred to as commercial paper.

Definition

A corporate bond is a bond issued by a corporation in order to raise financing for a variety of reasons such as to ongoing operations, mergers & acquisitions, or to expand business.[1] The term sometimes also encompasses bonds issued by supranational organizations (such as European Bank for Reconstruction and Development). Strictly speaking, however, it only applies to those issued by corporations. The bonds of local authorities (municipal bonds) are not included.[3]

Trading

Corporate bonds trade in decentralized, dealer-based, over-the-counter markets. In over-the-counter trading dealers act as intermediaries between buyers and sellers. Corporate bonds are sometimes listed on exchanges (these are called "listed" bonds) and ECNs. However, the vast majority of trading volume happens over-the-counter.[4]

High grade versus high yield

Corporate bonds are divided into two main categories High Grade (also called Investment Grade) and

High Yield (also called Non-Investment Grade, Speculative Grade, or Junk Bonds) according to their credit rating.[5] Bonds rated AAA, AA, A, and BBB are High Grade, while bonds rated BB and below are High Yield. This is a significant distinction as High Grade and High Yield bonds are traded by different trading desks and held by different investors.[6] For example, many pension funds and insurance companies are prohibited from holding more than a token amount of High Yield bonds (by internal rules or government regulation).[7] The distinction between High Grade and High Yield is also common to most corporate bond markets.[7]

Bond types

The

coupon (i.e. interest payment) is usually taxable for the investor. It is tax deductible for the corporation paying it. For US dollar corporates, the coupon is almost always semiannual, while Euro denominated corporates pay coupon quarterly.[8][9]

The coupon can be zero. In this case the bond, a zero-coupon bond, is sold at a discount (i.e. a $100 face value bond sold initially for $80). The investor benefits by paying $80, but collecting $100 at maturity. The $20 gain (ignoring time value of money) is in lieu of the regular coupon. However, this is rare for corporate bonds.

Some corporate bonds have an embedded call option that allows the issuer to redeem the debt before its maturity date. These are called callable bonds.[10] A less common feature is an embedded put option that allows investors to put the bond back to the issuer before its maturity date. These are called putable bonds. Both of these features are common to the High Yield market. High Grade bonds rarely have embedded options. A straight bond that is neither callable nor putable is called a bullet bond.

Other bonds, known as

secured or unsecured, senior or subordinated, and issued out of different parts of the company's capital structure.[11]

Valuation

Further information: Bond valuation

High grade corporate bonds usually trade at market interest rate but low grade corporate bonds usually trade on

required return is then used to discount the bond's cash flows, using the present value formula for bonds, to obtain the bond's price. See Bond (finance) § Bond valuation for discussion, and for the math, Bond valuation
.

Derivatives

The most common derivative on corporate bonds are called credit default swaps (CDS) which are contracts between two parties that provide a synthetic exposure with similar risks to owning the bond. The bond that the CDS is based on is called the Reference Entity and the difference between the credit spread of the bond and the spread of the CDS is called the Bond-CDS basis.

Risk analysis

Further information: Fixed income analysis § Analysis, and Yield spread § Yield spread analysis

Default risk

Compared to

credit spread) reflects the higher probability of default, the expected loss in the event of default, and may also reflect liquidity and risk premia; see Bond credit rating, High-yield debt
.

Other risks

Additional to default risk, as discussed, there are other risks for which corporate bondholders expect to be compensated through an increased credit spread. This explains, for example, the

MBS relative to the Treasury curve
.

Corporate bond indices

See also: bond market index

Corporate

bond indices
include the Barclays Corporate Bond Index, S&P U.S. Issued Investment Grade Corporate Bond Index (SPUSCIG), the Citigroup US Broad Investment Grade Credit Index, the JPMorgan US Liquid Index (JULI), and the Dow Jones Corporate Bond Index.

Corporate bond market transparency

Speaking in 2005, SEC Chief Economist Chester S. Spatt offered the following opinion on the transparency of corporate bond markets:

Frankly, I find it surprising that there has been so little attention to pre-trade transparency in the design of the U.S. bond markets. While some might argue that this is a consequence of the degree of fragmentation in the bond market, I would point to options markets and European bond markets-which are similarly fragmented, but much more transparent on a pre-trade basis.[14]

A combination of mathematical and regulatory initiatives are aimed at addressing pre-trade transparency in the U.S. corporate bond markets.

Foreign-currency denominated bonds

In February 2015 it was expected that

Swiss francs, as the yields of Switzerland's government bonds went negative.[15] Taking advantage of the very low borrowing costs, the computer maker intended to sell CHF-denominated bonds for the first time. The California-based company did sell positive-yield and Swiss franc-denominated bonds on 10 February 2015, borrowing CHF 1.25 billion (nearly equivalent to US$1.35 billion). It was thought that the company aimed to expand its total shareholder return more in 2015 than in 2014.[16]

See also

References

  1. ^
    ISBN 0-13-063085-3
    .
  2. ISBN 978-0-273-77986-5
    .
  3. S2CID 153537797
    .
  4. ISSN 0304-405X
    .
  5. ISSN 0015-198X
    .
  6. ISSN 0015-198X
    .
  7. ^
    ISBN 978-0-19-062597-9
    , retrieved 2023-11-06
  8. Securities and Exchange Commission
    .
  9. ISSN 0015-198X
    .
  10. ISSN 0022-3808
    .
  11. ISSN 0022-1090
    .
  12. S2CID 167055411
    .
  13. ^ Vuong, Quan Hoang; Tran, Tri Dung (2010). "Vietnam's Corporate Bond Market, 1990-2010: Some Reflections" (PDF). The Journal of Economic Policy and Research. 6 (1). Institute of Public Enterprises: 1–47. Archived from the original on Jan 13, 2015.{{cite journal}}: CS1 maint: unfit URL (link)
  14. ^ Spatt, Chester. "Broad Themes in Market Microstructure".
  15. ^ S. Bakewell (9 February 2015). "Apple said to hire banks for sale of Swiss franc bonds". Bloomberg Business.
  16. ^ B. Edwards (10 February 2015). "Apple Sells Two-Part Swiss Franc Bond". The Wall Street Journal.
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