What Are Corporate Bonds | How To Invest In Corporate Bonds

Summary

This video educates viewers on corporate bonds, distinguishing them from government-backed securities by highlighting their reliance on the issuer's credit. It explains the two main types: secured and unsecured bonds, and their repayment hierarchy in case of bankruptcy. The presenter emphasizes the historical low default risk of investment-grade corporate bonds and suggests starting with these over high-yield 'junk' bonds. It also covers how to invest in corporate bonds through platforms like Fidelity, Schwab, and Vanguard, detailing the purchasing process and fees.

Takeaways

• 📈 Corporate bonds, corporate debt, and corporates are used interchangeably, referring to bonds issued by both financial and non-financial companies.
• 🏦 Current top-yield corporate bonds are primarily offered by financial services companies, particularly banks, as they seek deposits.
• 💵 Corporate bonds are not backed by the U.S. government or any municipality but by the issuing company's credit and financial health.
• 📊 Corporate bonds are categorized into two main types: investment-grade (lower risk) and non-investment-grade (higher risk, also known as junk bonds).
• 💸 The likelihood of default for non-investment-grade bonds is significantly higher than for investment-grade bonds, but they offer potentially higher returns.
• 🏛️ There are two main types of corporate bonds: secured (backed by company assets) and unsecured (general claim to repayment). Secured bonds tend to be more common in non-investment-grade bonds.
• ⚖️ In the event of bankruptcy, secured bondholders have priority in recovering their investment, followed by senior unsecured, subordinated bondholders, and equity holders last.
• 🔍 Credit ratings are essential in assessing a company's financial health and default risk when investing in corporate bonds.
• 💹 Higher-risk bonds typically offer higher returns, but they also come with increased chances of default, especially in non-investment-grade debt.
• 🛠️ Corporate bonds can be purchased via brokers like Fidelity, Schwab, or Vanguard, with fees differing based on whether it's a new issue or a secondary market purchase.

Q & A

What are corporate bonds?

Corporate bonds are debt securities issued by private or public companies to raise funds. Investors who purchase these bonds are essentially lending money to the issuing company in exchange for regular interest payments and the return of the principal when the bond matures.

What is the difference between corporate bonds and government bonds?

Unlike government bonds, which are backed by the full faith and credit of the government, corporate bonds are backed solely by the credit and financial health of the issuing company. Corporate bonds carry a higher risk of default compared to government bonds.

What are the two main types of corporate bonds?

The two main types of corporate bonds are secured bonds and unsecured bonds. Secured bonds are backed by specific assets pledged as collateral, while unsecured bonds are not tied to any specific assets and rely on the company's general creditworthiness.

What is the role of a credit rating in assessing corporate bonds?

A credit rating assesses a company’s ability to meet its financial obligations and indicates the risk of default. Bonds are typically categorized into investment-grade (lower risk) and non-investment-grade or junk bonds (higher risk) based on their credit rating.

What is the difference between investment-grade and non-investment-grade bonds?

Investment-grade bonds have a lower risk of default, while non-investment-grade bonds, also called high-yield or junk bonds, have a higher risk of default. The difference in default risk leads to higher returns for non-investment-grade bonds to compensate for the increased risk.

What are callable corporate bonds?

Callable bonds are bonds that the issuing company can choose to pay back early, before the maturity date. This is often done if interest rates fall, allowing the company to refinance the debt at a lower rate.

How can an investor start investing in corporate bonds?

Investors can purchase corporate bonds through major brokers like Fidelity, Schwab, and Vanguard. They can buy either new issue bonds or trade them on the secondary market. Minimum purchase quantities typically start at $1,000 face value.

What are the risks associated with corporate bonds?

The main risk with corporate bonds is credit risk, the chance that the company may default on interest or principal payments. Additionally, unsecured bonds have a higher risk in case of bankruptcy, as they are lower in the repayment hierarchy than secured bonds.

What is the significance of bond hierarchy in case of company bankruptcy?

In case of bankruptcy, secured bondholders have the first claim on the pledged assets, followed by senior unsecured bondholders, and then subordinated bondholders. Equity holders are the last to be repaid. The higher a bondholder is in the hierarchy, the more likely they are to recover their investment.

What are the average recovery rates for different types of corporate bonds in bankruptcy?

According to S&P, the average recovery rates are: 65% for senior secured bonds, 48% for senior unsecured bonds, 35% for senior subordinated bonds, and 32% for subordinated bonds. These rates indicate how much investors typically recover in bankruptcy scenarios.