Understanding Investing
Corporate Bonds
After government bonds, the corporate bond market is the largest section of the global bond universe. With a
vast array of maturities, yields and credit quality available, investing in corporate bonds has the potential to
provide higher yields than government bonds and diversification benefits for investors.
WHAT ARE CORPORATE BONDS?
When companies want to expand operations or fund new
business ventures, they often turn to the corporate bond
market to borrow money. A company determines how much
it would like to borrow and then issues a bond offering in
that amount; investors that buy a bond are effectively lending
money to the company according to the terms established in
the bond offering or prospectus.
Unlike equities, ownership of corporate bonds does not
signify an ownership interest in the company that has issued
the bond. Instead, the company pays the investor a rate of
interest over a period of time and repays the principal at the
maturity date established at the time of the bond’s issue.
While some corporate bonds have redemption or call
features that can affect the maturity date, most are loosely
categorized into the following maturity ranges:
• Short-term notes (with maturities of up to five years)
• Medium-term notes (with maturities ranging between five
and 12 years)
• Long-term bonds (with maturities greater than 12 years)
In addition to maturity, corporate bonds are also categorized
by credit quality. Credit rating agencies such as Moody’s
Investors Service and Standard & Poor’s provide independent
analysis of corporate bond issuers, grading each issuer
according to its creditworthiness. Corporate bond issuers
with lower credit ratings tend to pay higher interest rates on
their corporate bonds.
HOW ARE CORPORATE BONDS RATED?
The corporate dividing line: investment-grade and
speculative-grade.
Corporate bonds fall into two broad credit classifications:
investment-grade and speculative-grade (or high yield)
bonds. Speculative-grade bonds are issued by companies
perceived to have a lower level of credit quality compared
to more highly rated, investment-grade, companies. The
investment-grade category has four rating grades while the
speculative-grade category is comprised of six rating grades.
MOODY’S
STANDARD
& POORS
Highest quality
(Best quality, smallest degree of
investment risk)
Aaa
AAA
High Quality
(Often called high-grade bonds)
Aa
AA
Upper medium grade
(Many favourite investment attributes)
A
A
Baa
BBB
Somewhat speculative
(Have speculative elements)
Ba
BB
Speculative
(Generally lack characteristics of a
desirable investment)
B
B
Highly speculative
(Bonds of poor standing)
Caa
CC
Most speculative
(Poor prospects)
Ca
CC
Imminent default
(Extremely poor prospects)
C
C
Default
C
D
INVESTMENT GRADE
Medium grade
(Neither highly protected nor poorly
secured)
SPECULATIVE GRADE
Historically, speculative-grade bonds were issued by
companies that were newer, were in a particularly
competitive or volatile sector or had troubling fundamentals.
Today, there are also many companies whose businesses are
2
Corporate Bonds
designed to operate with the degree of leverage traditionally
associated with speculative-grade companies. While a
speculative-grade credit rating indicates a higher default
probability, these bonds typically compensate investors for
the higher risk by paying higher interest rates, or yields.
Credit ratings can be downgraded if the credit quality of the
issuer deteriorates or upgraded if fundamentals improve.
Fallen angels, rising stars and split ratings
“Fallen angel” is a term that describes an investment-grade
company that has fallen on hard times and has subsequently
had its debt downgraded to speculative grade. “Rising star”
refers to a company whose bond rating has been increased by
a credit rating agency due to an improvement in the credit
quality of the issuer. Since the credit rating agencies’ ratings
are subjective, there are also times when they do not concur
on the rating – an occurrence known as a “split rating.”
Fallen angels, rising stars and split ratings may all present
opportunities for investors to add additional yield
by assuming greater risk due to the potential volatility of
their ratings.
HOW ARE CORPORATE BONDS PRICED?
The price of a corporate bond is influenced by several factors,
including the maturity, the credit rating of the company
issuing the bond and the general level of interest rates.
The yield of a corporate bond fluctuates to reflect changes
in the price of the bond caused by shifts in interest rates
and the markets’ perception of the issuer’s credit quality.
Most corporates typically have more credit risk and higher
yields than government bonds of similar maturities. This
divergence creates a credit spread between corporates and
government bonds, so that the corporate bond investor earns
extra yield by taking on greater risk. The credit spread affects
the price of the bond and can be graphically plotted and
measured as the difference between the yield of a corporate
and government bond at each point of maturity.
CREDIT SPREADS
YIELD%
AA- US corporate bond
credit spread
US treasury bond
MATURITY
HYPOTHETICAL EXAMPLE FOR ILLUSTRATIVE PURPOSES ONLY
WHY INVEST IN CORPORATE BONDS?
Corporate bonds can offer a range of potential benefits
including:
• Diversification: Corporates offer the opportunity to
invest in a variety of economic sectors. Within the broad
spectrum of corporates there is a wide divergence of risk
Corporate Bonds
and yield. Corporate bonds can add diversification
to an equity portfolio as well as diversify a fixed
income portfolio of government bonds or other fixed
income securities.
• Income: Corporates have the potential to provide
attractive income. Most corporate bonds pay on a fixed
semiannual schedule. One exception is zero-coupon
bonds, which do not pay interest but are sold at a deep
discount and then redeemed for full face value at maturity.
Another exception is floating-rate bonds that have
fluctuating interest rates tied to a money market reference
rate such as the London Interbank Offered Rate (LIBOR)
or federal funds rate. These tend to have lower yields than
fixed-rate securities of comparable maturities but also less
fluctuation in principal value.
• Higher yields: Corporates tend to provide higher yields
than comparable maturity government bonds.
• Liquidity: Corporate bonds can be sold at any time
prior to maturity in a large and active secondary
trading market.
WHAT ARE THE RISKS?
Similar to government bonds, corporate bonds are exposed
to interest rate risk. In addition, corporate bonds also have
credit or default risk - the risk that the borrower fails to
repay the loan and defaults on its obligation. The level of
default risk varies based on the underlying credit quality
of the issuer.
GLOSSARY
Coupon: The interest payments a bondholder receives until
the bond matures.
Corporate bond: Debt instrument issued by a company,
distinct from one issued by a government or government
agency.
Credit risk: The risk of loss of principal or loss of coupon
payments stemming from a borrower’s failure to repay a loan
or otherwise meet a contractual obligation.
Credit spread: The yield differential between a corporate
bond and an equivalent maturity sovereign bond. For example,
if the 10-year Treasury note is trading at a yield of 2% and a
10-year corporate bond is trading at a yield of 4%, the credit
spread is 2% or 200bps.
Fallen angel: An investment-grade company that has
subsequently had its debt downgraded to speculative grade.
Interest rate risk: When interest rates rise, the market value
of fixed-income securities (such as bonds) declines. Similarly,
when interest rates decline, the market value of fixed-income
securities increases.
Maturity: The number of years left until a bond repays its
principal to investors.
Rising star: A company whose bond rating has been
increased by a credit rating agency due to an improvement in
credit quality.
Yield: The income return or interest received from a bond.
3
Past performance is not a guarantee or a reliable indicator of future results.
The credit quality of a particular security or group of securities does not ensure the stability or safety of an overall portfolio.
The quality ratings of individual issues/issuers are provided to indicate the credit-worthiness of such issues/issuer and
generally range from AAA, Aaa, or AAA (highest) to D, C, or D (lowest) for S&P, Moody’s, and Fitch respectively.
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A word about risk: Investing in the bond market is subject to risks, including market, interest rate, issuer, credit,
inflation risk, and liquidity risk. The value of most bonds and bond strategies are impacted by changes in interest rates.
Bonds and bond strategies with longer durations tend to be more sensitive and volatile than those with shorter durations;
bond prices generally fall as interest rates rise, and the current low interest rate environment increases this risk. Current
reductions in bond counterparty capacity may contribute to decreased market liquidity and increased price volatility. Bond
investments may be worth more or less than the original cost when redeemed. Corporate debt securities are subject to
the risk of the issuer’s inability to meet principal and interest payments on the obligation and may also be subject to price
volatility due to factors such as interest rate sensitivity, market perception of the creditworthiness of the issuer and general
market liquidity. Certain U.S. government securities are backed by the full faith of the government. Obligations of U.S.
government agencies and authorities are supported by varying degrees but are generally not backed by the full faith of the
U.S. government. Portfolios that invest in such securities are not guaranteed and will fluctuate in value. Floating rate loans
are not traded on an exchange and are subject to significant credit, valuation and liquidity risk. Equities may decline in
value due to both real and perceived general market, economic and industry conditions. Diversification does not ensure
against loss.
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There is no guarantee that these investment strategies will work under all market conditions or are suitable for all investors
and each investor should evaluate their ability to invest long-term, especially during periods of downturn in the market.
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a recommendation of any particular security, strategy or investment product. Investors should consult their investment
professional prior to making an investment decision. Information contained herein has been obtained from sources believed
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