Corporate bonds

Lending money to a company

A corporate bond is one way for a company to raise money from investors to finance business activities. In return for your money, the company issuing the bonds promises to pay you interest at regular intervals and return the money you've invested on the maturity date.

Corporate bonds generally offer higher returns than cash, government bonds or bank term deposits, but less than shares. Corporate bonds are generally less risky than shares issued by the same company.

What are corporate bonds?

By investing in a corporate bond, you are lending money to a business in return for interest payments. 

Corporate bonds can provide regular interest payments (instalments), which may be fixed or variable (floating) in line with movements in a benchmark interest rate. These instalments are known as 'coupon payments'.

Coupon payments are backed by the bond issuer's cash flow or in some cases, the company's physical assets. See our bonds webpage for more information.

Different to shares

Buying corporate bonds is different to buying shares in a company. If you buy shares, you become a part owner of the business, may receive dividends and will share in any growth in the company. As a bond holder, you are considered a 'creditor' and your return is limited to interest payments and the return of the money you've invested.

Different to government bonds

A corporate bond is not the same as a government bond, which is a low-risk investment. See Australian Government bonds for more information about Commonwealth Government Securities (CGS), which are issued by the Commonwealth of Australia.

Bond or debenture?

A debenture is a type of corporate bond. To be called a debenture, the bond must be secured against property. A debenture is always a fixed rate investment. See unlisted debentures, secured & unsecured notes for more information.

Complex debt

Some other debt securities are types of corporate bonds, but are more complex investments and carry higher risks. See hybrid securities and subordinated notes for more information.

Buying corporate bonds

You can buy corporate bonds through a public offer (the primary market) or through a securities exchange (the secondary market).

If you buy corporate bonds through a public offer you will receive a prospectus and you can apply directly to buy the bonds. Public offers are usually advertised in newspapers and financial publications.

Before you invest, read the prospectus thoroughly so you understand the features and risks of the investment. 

You can buy (and sell) some corporate bonds on the Australian Securities Exchange (ASX) after they have already been issued in the primary market. If you buy bonds on the ASX you will pay the market price, which may be higher or lower than the face value of the bond. You will also pay a transaction fee to your broker.

See how bonds are valued for more information. 

If you are buying corporate bonds on the secondary market, the prospectus may be out of date. Check the issuing company's website or the ASX for the latest information on the bonds.

The pros and cons of corporate bonds 

Here are some advantages and disadvantages of investing in corporate bonds.

Bonds versus shares

Corporate bonds are generally less risky than shares issued by the same company. If the company fails and can't pay all its debts, bond holders generally rank higher than share holders.

Corporate bonds can offer a stream of coupon payments and the return of the principal on maturity. In contrast, the payment of share dividends is at the discretion of the company. 

The price of corporate bond are usually less volatile than shares for the same company. Buying shares and bonds from the same company is not diversification.

Income stream

If held to maturity, and subject to the issuer not defaulting on the promised repayments, you will receive regular interest payments. 

It is possible to design a relatively stable stream of income from corporate bonds by investing in bonds from different companies that have different maturity dates. 

Corporate bonds are unlikely to give you capital growth as they are generally not designed to increase in value during the time you have the investment.

Selling the bond before maturity

If you don't want to hold the bond until the maturity date and decide to sell it on a secondary market, you may get a lower price than the face value. 

There may also be fewer potential buyers for the bond. This can be a problem if you need to get your money back quickly.

Assessing the risks of a corporate bond

The return offered by a corporate bond is not the only way to assess the investment. It's also important to understand the risks. 

Credit risk

The main risk with corporate bonds is that you may not receive interest payments or get your money back if the company issuing the bonds goes out of business. This is known as 'credit risk'. 

Consider the business environment the company operates in. 

  • Which country is it in? 
  • What is the outlook (future demand, cost pressures and competition) for the industries it operates in? 
  • How good are the management and/or owners? 

You can also asses a company's ability to meet its financial obligations by reviewing the pro forma financial information in the prospectus (or if you buy bonds after they are first issued, the company's most recent financial statements). Ideally, the company should have low levels of debt and plenty of cash to service it. 

Find out the following information about the company so you can assess its credit risk:

  • Financial performance over time - Look for strong earnings, profitability and cash flow
  • Ability to pay interest on debts (interest coverage ratio) - The company should earn enough from its business operations to cover interest payments on money it borrows. Make sure that the company's earnings are comfortably larger than net interest expenses.
  • Level of debt or leverage (gearing ratio) - A good indicator is a ratio that measures total liabilities divided by shareholder equity. The higher this ratio, the more highly leveraged the company.
  • Defaults on debt obligations - Check whether the company has defaulted on any current or previous debt obligations or if there is a significant amount of debt that will be maturing soon.

Security and ranking

When a company becomes insolvent, its assets may have to be sold, with the proceeds distributed to everyone who has a stake in the company. Read the prospectus to see what assets the bonds are secured against or if they're unsecured. Also check your ranking in the list of creditors.

Prepayment (or early redemption) risk

This is the risk that the issuer will redeem the bonds early if interest rates fall and the market price goes up. If this happens, you will be paid the face value of the bonds (you may have paid more for them or they may be worth more on the secondary market). 

The prospectus should tell you the circumstances under which early redemption is possible.

Investment check list for corporate bonds

Use this checklist to help you decide whether corporate bonds are the right investment for you. The prospectus for the bonds as well as ASIC's guide to investing in corporate bonds will help you answer these questions. 

  • When does the bond mature?
  • What is the length of the bonds' term in years?
  • Is interest paid at a fixed or floating rate?
  • If they are floating rate bonds, do you understand how the interest is calculated?
  • How often will you be paid interest?
  • Does the company have the financial capacity to pay you interest and return your principal at maturity?
  • Do you understand that you may lose money if you sell your bonds on the market?
  • Are the bonds secured or unsecured?
  • Where do you stand in relation to other creditors if the company issuing the bonds can't repay its debts?
  • Can the company issuing the bonds buy them back before the maturity date?

It's important that you carefully assess the features, terms and conditions of each corporate bond, as the risks can vary. Seek financial advice from a licensed adviser if you need further information or guidance on how corporate bonds can be used to meet your investment needs.

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Last updated: 12 Dec 2018