Corporate bonds are used by many companies to raise funding for large-scale projects - such as business expansion, takeovers, new premises or product development. They can be used to replace bank finance, or to provide long-term working capital.
The main features of a corporate bond are:
- the nominal value - the price at which the bonds are first sold on the market
- the interest rate paid to the bond owner - this is usually fixed
- the redemption date - when the nominal value of the bond must be repaid to the bond holder
Bonds can be sold on the open market to investment institutions or individual investors, or they can be placed privately. For more information, see advantages and disadvantages of raising finance through private placements.
If bonds are sold on the public market, they can be traded - similar to shares. Some corporate bonds are structured to be convertible, which means they can be exchanged for shares at some point in the future.
Advantages of issuing corporate bonds
Bonds can be a very flexible way of raising debt capital. They can be secured or unsecured, and you can decide what priority they take over other debts. They can also offer a way of stabilising your company's finances by having substantial debts on a fixed-rate interest. This offers some protection against variable interest rates or economic changes.
Other advantages of using bonds to raise long-term finance include:
- not diluting the value of existing shareholdings - unlike issuing additional shares
- enabling more cash to be retained in the business - because the redemption date for bonds can be several years after the issue date
Disadvantage of issuing corporate bonds
There are also some disadvantages to issuing bonds, including:
- regular interest payments to bondholders - though interest may be fixed, the interest will usually have to be paid even if you make a loss
- the potential for your business' share value to be reduced if your profits decline - this is because bond interest payments take precedence over dividends
- bondholder restrictions - because investors are locking up their money for a potentially long period of time, they can impose certain covenants or undertakings on your business operations and financial performance to limit their risk
- ongoing contact with investors can be somewhat limited so changes to terms and conditions or waivers can be more difficult to obtain compared to dealing with bank lenders, who tend to maintain a closer relationship
- having to comply with various listing rules in order to increase the tradability of the bonds listed on an exchange - particularly, an obligation to make information on the company publicly available at the issue stage and regularly during the life of the bond
Additionally, although it isn't a mandatory requirement, having a credit rating can help you launch a successful bond issue. However, this is time consuming and will be an added cost to issuing the bonds.
FAQs
Corporate bonds aren't backed by the government, so they aren't as safe as Treasurys, but that means they'll typically offer higher yields. The interest rate available will depend on the financial strength of the company doing the borrowing.
What are corporate bonds advantages and disadvantages? ›
Corporate bonds aren't backed by the government, so they aren't as safe as Treasurys, but that means they'll typically offer higher yields. The interest rate available will depend on the financial strength of the company doing the borrowing.
What are the advantages and disadvantages of issuing bonds? ›
Bonds have some advantages over stocks, including relatively low volatility, high liquidity, legal protection, and various term structures. However, bonds are subject to interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.
What is a disadvantage for a corporation of issuing a bond? ›
Bonds do have some disadvantages: they are debt and can hurt a highly leveraged company, the corporation must pay the interest and principal when they are due, and the bondholders have a preference over shareholders upon liquidation.
What are the advantages of raising funds through bonds? ›
Advantages of issuing corporate bonds
Bonds can be a very flexible way of raising debt capital. They can be secured or unsecured, and you can decide what priority they take over other debts. They can also offer a way of stabilising your company's finances by having substantial debts on a fixed-rate interest.
What are the benefits of issuing corporate bonds? ›
The ability to borrow large sums at low interest rates gives corporations the ability to invest in growth and other projects. Issuing bonds also gives companies significantly greater freedom to operate as they see fit. Bonds release firms from the restrictions that are often attached to bank loans.
What are the risks of issuing corporate bonds? ›
Risk Considerations: The primary risks associated with corporate bonds are credit risk, interest rate risk, and market risk. In addition, some corporate bonds can be called for redemption by the issuer and have their principal repaid prior to the maturity date.
What are the advantages of issuing bonds vs stocks? ›
Advantages of Issuing Bonds Instead of Stock
There are several advantages of issuing bonds (or other debt) instead of issuing shares of common stock: Interest on bonds and other debt is deductible on the corporation's income tax return while the dividends on common stock are not deductible on the income tax return.
Are corporate bonds safe or not? ›
In the investment hierarchy, high-quality corporate bonds are considered a relatively safe and conservative investment. Investors building balanced portfolios often add bonds in order to offset riskier investments such as growth stocks.
Which is a disadvantage of issuing bonds Quizlet? ›
The disadvantages of issuing bonds include the following: (1) because bonds are an increase in debt, they may adversely affect the market's perception of the company; (2) the firm must pay interest on its bonds; and (3) the firm must repay the bond's face value on the maturity date.
Bonds tend to be less volatile and less risky than stocks, and when held to maturity can offer more stable and consistent returns. Interest rates on bonds often tend to be higher than savings rates at banks, on CDs, or in money market accounts.
What are the disadvantages of bond funds? ›
The disadvantages of bond funds include higher management fees, the uncertainty created with tax bills, and exposure to interest rate changes.
What are the pros and cons of selling bonds compared to issuing stock or borrowing money from a bank in terms of raising capital? ›
Pros and Cons – Bonds vs Stocks
However, in return for the risk, stockholders have a greater potential return. Bonds are more beneficial for investors who want less exposure to risk but still want to receive a return. Fixed-income investments are much less volatile than stocks, and also much less risky.
What is a corporate bond? ›
What is a corporate bond? A bond is a debt obligation, like an Iou. Investors who buy corporate bonds are lending money to the company issuing the bond. In return, the company makes a legal commitment to pay interest on the principal and, in most cases, to return the principal when the bond comes due, or matures.
