Corporate bonds: how companies borrow from investors

When a company needs to borrow large sums, it can issue corporate bonds instead of relying only on banks. This guide explains what corporate bonds are, how they work and the risks and returns they carry for investors.

Quick answer

Corporate bonds are debt securities issued by companies to raise money from investors. The company borrows the amount, promises to pay interest at a set rate and to repay the principal on a future date. Corporate bonds usually offer higher interest than government bonds, but they carry more risk that the company may fail to pay.

Key takeaways

• Corporate bonds are debt securities issued by companies.
• The company pays interest and repays the amount later.
• They usually offer higher interest than government bonds.
• They carry more risk that the company may default.
• Credit ratings help gauge that risk.

What are corporate bonds?

Corporate bonds are a way for companies to borrow money directly from investors. Instead of taking a bank loan, a company issues bonds, and investors who buy them are effectively lending the company money.

In return, the company promises to pay interest at a set rate over the life of the bond and to repay the original amount, the principal, on a future maturity date.

How do corporate bonds work?

When you buy a corporate bond, you receive regular interest payments, often called the coupon. When the bond matures, you get back the principal, assuming the company can pay.

After they are issued, corporate bonds can often be traded in the bond market. Their prices move with interest rates and with how safe investors think the issuing company is.

Why do companies issue them?

Companies issue bonds to raise money for things like expansion, projects or refinancing older debt. Bonds can let them borrow large sums from many investors, sometimes at better terms than a single loan.

For the company, bonds are a flexible way to fund growth. For investors, they offer a way to earn interest that is often higher than on government bonds.

What are the risks?

The main risk is credit risk, the chance the company cannot pay the interest or repay the principal. A weaker company must usually offer higher interest to attract buyers, reflecting the greater risk.

Credit ratings from rating agencies help investors gauge this risk, with higher ratings suggesting lower risk. Bond prices also fall when interest rates rise, so there is market risk too.

How should investors think about them?

Corporate bonds can offer steady interest and a way to diversify beyond shares, but the higher return compared with government bonds comes with higher risk. Checking the credit rating and the company's health matters.

Understanding corporate bonds helps you weigh income against risk in a portfolio. Any investment decision should be your own after proper research and reading all related documents.

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