What are Corporate Bonds? - Definition & Examples Video

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  • 0:04 Bonds
  • 0:56 What Are Corporate Bonds?
  • 1:36 Advantages
  • 2:21 Disadvantages
  • 3:21 Lesson Summary
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Lesson Transcript
Instructor: Tammy Galloway

Tammy teaches business courses at the post-secondary and secondary level and has a master's of business administration in finance.

In this lesson, we'll explore corporate bonds and how they relate to an investor's risk tolerance. You'll also learn about the advantages and disadvantages of corporate bonds.

Bonds

Jon has a job with a six figure salary and is interested in investing. He meets with Nickole, a financial planner, and completes a risk tolerance assessment. Risk is a chance of financial loss, and the assessment analyzes Jon's sensitivity to risk. Nickole tallies the results and finds that Jon has a medium to low risk tolerance level. This means he wants to make money from the investment, but doesn't want to lose any.

Nickole suggests Jon begin investing in bonds. Bonds are a contractual arrangement, similar to an IOU, whereby the investor lends money to a company and the company promises to pay it back. There are three main types of bonds: US government, local government, and corporate bonds.

For the rest of this lesson, we will explore corporate bonds and their advantages and disadvantages.

What Are Corporate Bonds?

When a company wants to expand, it has a few options for borrowing money, including seeking a bank loan or selling bonds. Corporate bonds are usually sold in increments of $1,000. The $1,000 is the initial investment and is called the principal.

When investors purchase bonds, they give the corporation $1,000 per bond and the corporation pays the investor annual interest payments. Interest is a fee to paid to the investor to borrow money. When the bond matures, the corporation will pay the investor back their original investment. After Nickole explains corporate bonds, Jon asks, 'What are other advantages besides receiving annual interest payments?'

Advantages

Nickole tells Jon that one main advantage of corporate bonds is that the company is legally obligated to pay interest and return the principal at maturity. Based on that fact, bonds are low risk.

Since companies are bound by law to pay interest and the principal, there is little chance of the company defaulting on the loan, meaning there is little chance Jon won't receive his money.

Another advantage of investing in bonds is having known earnings projections. Since the amount he will receive is set forth in a contract, Jon knows how much he'll earn annually and the amount he'll receive at maturity (with other investment products, the investor has no guaranteed return on their investment). Jon asks Nickole, 'All the advantages sound great, but are there any disadvantages?'

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