A corporate bond is a loan you make to a company, and the company pays you back with interest

When you buy a corporate bond, you are lending money to a business. The company promises to pay you back the full amount on a set date, called the maturity date, and to pay you interest along the way. That interest is called the coupon. You are not buying a piece of the company the way you would with stock — you are a creditor, not an owner. The company owes you money, and that debt is what the bond represents.

Corporate bonds come from companies of all sizes and industries. A manufacturer might issue bonds to build a new factory. A retailer might issue bonds to pay off other debts. A utility company might issue bonds to upgrade its power lines. The company chooses how much money to borrow, how long to borrow it for, and what interest rate to offer. The higher the risk that the company might not pay you back, the higher the interest rate has to be to attract lenders.

Key Takeaways

  • A corporate bond is a debt security — the company owes you money and must repay it on the maturity date plus interest.
  • You receive interest payments, usually twice a year, at a rate set when the bond is issued and fixed for the life of the bond.
  • The price of a bond on the secondary market moves up and down based on interest rates and the company's financial health, even though the interest payment stays the same.
  • Corporate bonds are riskier than government bonds because companies can default, but they pay higher interest to compensate for that risk.
  • You can hold a bond until maturity and get your full principal back, or sell it before maturity at whatever price the market will pay.

How interest payments work on a corporate bond

When you buy a corporate bond, the company sets an interest rate at the time of issue. This rate is called the coupon rate, and it does not change for the life of the bond. If you buy a $1,000 bond with a 5 percent coupon, you will receive $50 per year in interest. Most companies pay this in two installments — $25 every six months.

The coupon rate is fixed, but the actual yield you earn depends on what you paid for the bond. If you buy the bond when it is first issued at $1,000, your yield matches the coupon rate. If you buy the same bond later on the secondary market for $900 because interest rates have risen, your yield is higher — you are still getting $50 per year, but on a $900 investment. If you buy it for $1,100 because interest rates have fallen, your yield is lower. The bond itself does not change, but your return does.

The difference between investment-grade and high-yield bonds

Corporate bonds are sorted by risk using ratings from agencies like Moody's, Standard & Poor's, and Fitch. Investment-grade bonds are issued by companies with strong finances and a low risk of default. These bonds carry ratings of BBB or higher (the exact letter scale varies by agency). They pay lower interest because the risk is lower.

High-yield bonds, also called junk bonds, are issued by companies with weaker finances or shorter track records. These bonds carry ratings below BBB. They pay much higher interest because the risk of default is higher. A company might offer 8 or 10 percent interest on a high-yield bond, while an investment-grade bond from a stable company might pay only 4 or 5 percent. The higher payment is the trade-off for accepting the higher risk.

What happens if you sell a bond before maturity

You do not have to hold a bond until the maturity date. You can sell it on the secondary market — the market where existing bonds trade between investors — at any time. The price you get depends on what has happened to interest rates and the company's financial condition since you bought it.

If interest rates have fallen since you bought the bond, your bond becomes more valuable because it pays a higher coupon than new bonds being issued. You can sell it for more than you paid. If interest rates have risen, your bond becomes less valuable because new bonds pay higher coupons. You can only sell it for less than you paid. If the company's credit rating drops because its finances have weakened, the bond's price falls. If the company's credit rating improves, the bond's price rises. The maturity date does not change, but the market price does.

The risk that a company will not pay you back

The biggest risk with a corporate bond is default — the company fails to pay the interest or principal you are owed. This can happen if the company runs out of money, faces a major lawsuit, loses a key customer, or encounters any other financial crisis. If a company defaults, you may recover some of your money through bankruptcy proceedings, but you may also lose it all. Your position in the bankruptcy line depends on the type of bond you hold and what other debts the company has.

Government bonds carry almost no default risk because the government can print money or raise taxes. Corporate bonds carry real default risk, which is why they pay higher interest. The rating agencies try to measure this risk, but ratings are not perfect. A company can be downgraded suddenly if bad news emerges. This is why diversification matters — holding bonds from many different companies and industries reduces the damage if one company defaults.

How corporate bonds fit into a portfolio

Corporate bonds are often used to balance the risk in a portfolio that also holds stocks. Stocks can be volatile — their prices swing up and down — but bonds are more stable. A bond pays a fixed interest payment whether the stock market is up or down. If you hold a bond to maturity, you know exactly what you will get back.

Corporate bonds also pay more interest than savings accounts or money market funds, so they can help you reach income goals. The trade-off is that you have to accept some risk of default and some price volatility if you sell before maturity. Many investors hold a mix of investment-grade corporate bonds, government bonds, and stocks, adjusting the mix based on how much risk they can tolerate and how much income they need.

Where corporate bonds are bought and sold

You can buy corporate bonds through a brokerage account, the same way you buy stocks. Your broker can show you bonds that are currently available, their coupon rates, maturity dates, and credit ratings. You can also buy corporate bonds through mutual funds or exchange-traded funds (ETFs) that hold a basket of bonds. This approach spreads your money across many bonds and many companies, which reduces the impact of any single default.

The corporate bond market is large and active. Thousands of bonds trade every day. However, not all bonds are equally straightforward to buy and sell. Bonds from large, well-known companies are highly liquid — you can buy or sell them quickly at a price close to the last trade. Bonds from smaller companies may be less liquid, meaning fewer buyers and sellers, wider price spreads, and slower transactions. Your broker can tell you how liquid a specific bond is before you buy.

Frequently Asked Questions

What is the difference between a corporate bond and a stock?

A bond is a loan — the company owes you money and must pay it back. A stock is ownership — you own a piece of the company. If the company does well, stock owners benefit from rising prices and dividends. If the company fails, stock owners lose their investment after all creditors, including bond holders, are paid. Bonds are generally less risky but also offer less upside.

Can a corporate bond be called before the maturity date?

Many corporate bonds include a call feature, which means the company can pay off the bond early if it chooses. Companies usually call bonds when interest rates fall, because they can then issue new bonds at a lower rate. If your bond is called, you get your principal back but lose the higher interest payments you were expecting. The bond's prospectus will tell you if it is callable and when.

How do I know if a corporate bond is safe?

Check the credit rating from Moody's, Standard & Poor's, or Fitch. Investment-grade ratings (BBB or higher) indicate lower default risk. You can also read the company's financial statements and news to understand its business and financial health. Diversification also matters — holding bonds from many companies reduces the risk that any single default will hurt you badly.

What happens to my bond if the company is acquired?

The bond terms do not automatically change when a company is acquired. The new owner inherits the debt and must continue paying the interest and principal. However, if the acquisition involves a change in credit quality — for example, if a strong company buys a weak one — the bond's rating and price may change. Read the bond's prospectus to see if there are any special provisions related to mergers or acquisitions.

Do I have to pay taxes on corporate bond interest?

Yes. The interest you receive from a corporate bond is taxable income at the federal level and usually at the state and local level as well. You will receive a Form 1099-INT from your broker showing the interest you earned, and you must report it on your tax return. This is different from municipal bonds, which are often tax-free. The after-tax return on a corporate bond is lower than the stated coupon rate if you are in a high tax bracket.