Several types of bonds are issued by governments and large organizations for different reasons. One such type of bond is the corporate bond.
Companies or firms issue this kind of bond to cover their expenses. Corporate bonds are known to yield more profits than government-issued bonds. However, one should remember that with greater profits comes greater risk too.
Companies tend to operate in different markets; therefore, corporate bonds are classified into groups according to the companies’ market area.
Types of Corporate Bonds
Corporate bonds can be classified into five major categories. These are industrials, transportations, international issues, banking and finance firms, and public utilities. These categories are further divided into sub-categories. For instance, the category of transportation further includes roadways, airlines, and other automobile firms.
1. Security of bonds
As the name suggests, this category acts as a backup option in case an issue arises in the company. Many investors opt for this option since it acts as a protective wall whenever there’s a risk of losing money due to a corporate problem. The best part about this option is that in case of financial concern, it provides assets that are more than the actual amount spent by the investor.
2. Mortgage bonds
There are various assets that back up a bond. With mortgage bonds, holders have the power to sell mortgaged properties and clear the pending transactions.
3. Collateral trust bonds
These types of bonds are quite like mortgage bonds. The major exception in this case, however, is that Collateral trust bonds do not have the backing of a property or a house. Collateral trust bonds are possessed by firms that do not have the ownership of assets or property.
Instead of owning such fixed assets, these companies have investments in securities of other companies. When they issue bonds, it is these assets such as bonds, shares, and other investments in various companies that they pledge.
4. Equipment trust certificates
Equipment trust certificates, or ETCs, are sold to pay for some equipment. For instance, if a company requires some vehicles, it places an order with the manufacturer. The manufacturer fulfills the order and makes a trustee the owner of the vehicles.
This trustee pays the vehicle manufacturer by selling equipment trust certificates to investors. The interest on these certificates is paid by collecting rent from the company. When the note reaches maturity, the trustee hands over the title of the vehicle to the company.
The renting of the vehicle is not really a leasing arrangement, as the company receives the title to the vehicle only when the ETC agreement ends. Therefore, equipment trust certificates are actually a form of secured debt financing.
5. Debenture bonds
Unsecured bonds that are not backed by other assets are called debenture bonds, such as Treasury Bills, which are a kind of government bonds.
Companies that enjoy consistently strong credit rating issue Debenture bonds. So the investors cannot expect very high-interest rates from them. Companies that have previously offered mortgage or collateral bonds can also issue debenture bonds. However, the quality of such debenture bonds is considered to inferior.
6. Convertible debentures
Debenture bonds can also be converted into a fixed number of shares of a company after a specific time period. For obvious reasons, investors find these convertible bonds quite attractive and because of this, the coupon rates they offer are low.
7. Guaranteed bonds
These are bonds that are, well, guaranteed. It is another corporation that provides this guarantee. For investors, this ensures a reduced risk of default, because a second corporation has pledged to take on the liability and honour the bond’s terms if and when it is required. But this does not mean that the default risk of the bond is totally eliminated. It is quite possible that the corporation giving the guarantee also fails to honour its contract.
8. High yield corporate bonds
Another name for these bonds is junk bonds. And rating agencies consider them below investment grade. As mentioned previously, with more profits comes greater risk and this bond is no exception. However, the greater risk associated with this bond does not mean that company that issued these bonds has a chance of going down in the future.
The Difference between Corporate Bonds and Stocks
There is quite a difference between buying a bond and a share. With bond investments a person who invests in bonds is lending his/her capital to the firm. On the other hand, an individual investing in stock purchases a percentage of ownership of the firm.
With the fluctuation in stock prices, the investor makes profits by purchasing and selling them. The company in which the individual buys shares in also offers to pay dividends. This makes for an additional income for the investor. Whereas in case of bond investments, the individual is gets interest by the organization instead of profits.
Bonds, in general, are a stable investment option and corporate bonds as a type of bond are one of the best profit-making options.