Getting to know ... corporate bonds
02 February, 2016
Bonds can seem confusing to even seasoned investors, not least because of the various shapes and sizes they come in. Over recent months, the bond market has been preoccupied with the impact that higher interest rates could have on corporations and their bonds.
Corporate bonds are essentially a loan taken out by a company. They generally have a set date in the future when they mature and carry a pre-agreed interest rate. Uniquely, these two features make it possible to calculate what the return of the investment is going to be at the time you first buy it — provided you hold the investment to maturity and the company meets its financial obligations.
Despite this certainty of return, a corporate bond's value will still fluctuate. A major reason is the perceived risk that the borrower might not be able to meet their future repayment promise. A rise in this credit or default risk can come from either company-specific issues or a worsening of the broader economic environment making it harder for all companies to make money. As investors in all global markets have become more risk averse and uncertain about the future, it is the latter that investors seem most concerned about.
The sell-off of corporate bonds over recent months has led to a significant improvement in the valuation across many parts of the global corporate bond market. This is all the more striking considering that a recovery in the price of these bonds is not required to achieve the new and greatly improved expected returns they offer.