4 Things to Know Before Buying Corporate Bonds

Buying corporate bonds allows you to earn profits while providing much-needed financing to whichever company they bought the bonds from. The corporate bonds are issued by industrial, financial and service companies to generate funds for capital investment and operating cash flow. In other words, corporate bonds are essentially small portions of a large loan. You earn profit through a combination of interest and principle payments. In order to be able to buy corporate bonds and earn profit in the process, there are a few things you must understand. 

Corporate Bonds Basics

Each corporate bond is usually worth a multiple of $1,000 or $5,000. When you buy a corporate bond, the company that issued it agrees to repay it after a certain fixed number of years. That repayment is known as the principle. Until the principle is paid, the company will make interest payments (or, as they are known in bond markets, coupons) on either annual or semi-annual basis. The interest rate is set based on the inflation, interest rates and other economic variable on the day before it was sold. The interest payments are taxable, but the principle is not. 

Primary Markets vs Secondary Markets

There are two ways you can buy corporate bonds - in primary market or in secondary market. In primary market, you buy the bonds directly. However, in primary markets, the bonds are usually sold in large bundles, the primary markets are usually reserved for wealthy investors, investment firms and institutional investors - investing organizations that pool their members' resources together to buy bonds. Institutional investors can be banks, insurance companies and various funds. Those who buy bonds on primary markets then sell them to secondary markets for more affordable prices. The sales are conducted through an "over-the-counter" network of securities firms, brokers and dealers. 

How Can You Purchase Corporate Bonds

You can buy corporate bonds through your broker, who would be able to buy bonds in the secondary markets. You may also be able to buy them through a bank or financial institution in your area, provided they buy bonds on primary markets. Both will charge you some sort of commission. If possible, try to consult a financial adviser if at all possible before you commit to buying anything. Unlike the brokers, the financial adviser has no financial stake in whether or not you buy a corporate bond, which allows him or her to give you a more impartial advice. Failing that, try to research them on your own. 

Profit vs Risk

Corporate bonds are more profitable than many other types of bonds. The fact that their rates and payment terms are fixed gives them a measure of stability. However, they are still vulnerable to defaults. While the corporate bonds from recently established companies are especially vulnerable to defaults, the long-running companies aren't immune from them, either.

You can try to lower the risk by buying corporate bonds with shorter repayment times. The more time they have to repay, the more likely it is that something will go wrong, be it an internal factor or the state of the economy in general.

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