What are corporate bonds?
Quick Take on Fixed Income
Question: What are corporate bonds?
Answer: Corporate bonds are debt securities issued by corporations. The bonds have a maturity greater than one year, and interest income is taxable at local, state and federal levels. These bonds are the obligation of the issuing company, which can issue many bonds with different maturities and characteristics to finance its operations. The bonds are backed by the company’s ability to make interest and principal payments or hard assets used as collateral. The Securities Industry and Financial Markets Association reported that corporations issued almost $1.5 trillion in bonds in 2014.
Credit rating agencies give companies letter grades based on their financial strength. Each agency has a different approach to rating companies and municipalities to determine credit worthiness. As shown below, corporate bond issuers do not compare favorably to municipal issuers when viewed within the strict buying parameters (Aa3 or higher) of BAM’s Fixed Income Desk, with whom we work to build our clients’ bond portfolios. Municipal bonds also hold their credit rating better than corporate bonds. For example, according to Moody’s data covering 1970–2014, Aa rated municipal bonds hold their rating 95 percent of the time, while similarly rated corporates bonds retain their rating roughly 84 percent of the time. Corporate bonds tend to have lower credit ratings on average and get downgraded more frequently than their municipal counterparts.
From 1927–2014, corporate bonds on average returned only 0.3 percent more than their Treasury equivalents. High-quality corporate bonds also tend to yield less than brokered CDs to the tune of 10–30 basis points depending on maturity. The small premium for taking on corporate risk, coupled with the lower yields compared with brokered CDs, leads BAM’s Fixed Income Desk to not recommend purchasing corporate bonds. For clients that might require additional return, the equity markets have historically rewarded that risk much better.
Copyright © 2015, The BAM ALLIANCE. This material and any opinions contained are derived from sources believed to be reliable, but its accuracy and the opinions based thereon are not guaranteed. The content of this publication is for general information only and is not intended to serve as specific financial, accounting or tax advice. To be distributed only by a Registered Investment Advisor firm. Information regarding references to third-party sites: Referenced third-party sites are not under our control, and we are not responsible for the contents of any linked site or any link contained in a linked site, or any changes or updates to such sites. Any link provided to you is only as a convenience, and the inclusion of any link does not imply our endorsement of the site.