Corporate bonds are used by many companies to raise funding for large-scale projects - such as business expansion, takeovers, new premises or product development. They can be used to replace bank finance, or to provide long-term working capital.
The main features of a corporate bond are:
- the nominal value - the price at which the bonds are first sold on the market
- the interest rate paid to the bond owner - this is usually fixed
- the redemption date - when the nominal value of the bond must be repaid to the bond holder
Bonds can be sold on the open market to investment institutions or individual investors, or they can be placed privately. For more information, see advantages and disadvantages of raising finance through private placements.
If bonds are sold on the public market, they can be traded - similar to shares. Some corporate bonds are structured to be convertible, which means they can be exchanged for shares at some point in the future.
Advantages of issuing corporate bonds
Bonds can be a very flexible way of raising debt capital. They can be secured or unsecured, and you can decide what priority they take over other debts. They can also offer a way of stabilising your company's finances by having substantial debts on a fixed-rate interest. This offers some protection against variable interest rates or economic changes.
Other advantages of using bonds to raise long-term finance include:
- not diluting the value of existing shareholdings - unlike issuing additional shares
- enabling more cash to be retained in the business - because the redemption date for bonds can be several years after the issue date
Disadvantage of issuing corporate bonds
There are also some disadvantages to issuing bonds, including:
- regular interest payments to bondholders - though interest may be fixed, the interest will usually have to be paid even if you make a loss
- the potential for your business' share value to be reduced if your profits decline - this is because bond interest payments take precedence over dividends
- bondholder restrictions - because investors are locking up their money for a potentially long period of time, they can impose certain covenants or undertakings on your business operations and financial performance to limit their risk
- ongoing contact with investors can be somewhat limited so changes to terms and conditions or waivers can be more difficult to obtain compared to dealing with bank lenders, who tend to maintain a closer relationship
- having to comply with various listing rules in order to increase the tradability of the bonds listed on an exchange - particularly, an obligation to make information on the company publicly available at the issue stage and regularly during the life of the bond
Additionally, although it isn't a mandatory requirement, having a credit rating can help you launch a successful bond issue. However, this is time consuming and will be an added cost to issuing the bonds.
FAQs
Corporate bonds aren't backed by the government, so they aren't as safe as Treasurys, but that means they'll typically offer higher yields. The interest rate available will depend on the financial strength of the company doing the borrowing.
What are corporate bonds' advantages and disadvantages? ›
Corporate bonds aren't backed by the government, so they aren't as safe as Treasurys, but that means they'll typically offer higher yields. The interest rate available will depend on the financial strength of the company doing the borrowing.
What are the advantages and disadvantages of issuing bonds? ›
Bonds have some advantages over stocks, including relatively low volatility, high liquidity, legal protection, and various term structures. However, bonds are subject to interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.
What is a disadvantage for a corporation of issuing a bond? ›
Bonds do have some disadvantages: they are debt and can hurt a highly leveraged company, the corporation must pay the interest and principal when they are due, and the bondholders have a preference over shareholders upon liquidation.
What are the disadvantages of corporate financing? ›
The drawbacks of corporate financing[Original Blog]
For one thing, it can be expensive. Interest rates on corporate loans are usually higher than those on other types of loans, and fees can add up. Another downside of corporate financing is that it can be difficult to get approved for a loan.
What are the benefits of issuing corporate bonds? ›
The ability to borrow large sums at low interest rates gives corporations the ability to invest in growth and other projects. Issuing bonds also gives companies significantly greater freedom to operate as they see fit. Bonds release firms from the restrictions that are often attached to bank loans.
What are the advantages of issuing bonds? ›
Advantages of issuing corporate bonds
Bonds can be a very flexible way of raising debt capital. They can be secured or unsecured, and you can decide what priority they take over other debts. They can also offer a way of stabilising your company's finances by having substantial debts on a fixed-rate interest.
What are three disadvantages of bonds? ›
Cons of Buying Bonds
- Values Drop When Interest Rates Rise. You can buy bonds when they're first issued or purchase existing bonds from bondholders on the secondary market. ...
- Yields Might Not Keep Up With Inflation. ...
- Some Bonds Can Be Called Early.
Risk Considerations: The primary risks associated with corporate bonds are credit risk, interest rate risk, and market risk. In addition, some corporate bonds can be called for redemption by the issuer and have their principal repaid prior to the maturity date.
What are the disadvantages and disadvantages of corporation? ›
Here are some disadvantages to forming your business as a corporation:
- A corporation is a distinct legal entity. The business is governed by a board of directors. ...
- Double-taxation. Corporations pay taxes on profits distributed to shareholders. ...
- More complicated to form. ...
- More requirements. ...
- Higher costs.
After bonds are initially issued, their worth will fluctuate like a stock's would. If you're holding the bond to maturity, the fluctuations won't matter—your interest payments and face value won't change.
Which answer is a disadvantage of a bond? ›
Disadvantages of Investing in Bonds
- Lower returns: Compared to other types of investments, such as stocks, bonds may offer lower returns. ...
- Inflation risk: It can reduce the purchasing power of the fixed returns offered by bonds. ...
- Interest rate risk: Prices of bonds are inversely related to the interest rates.
Maximizing Shareholder Value: Corporate finance helps a company maximize shareholder value by increasing profitability and share price. This involves making decisions that enhance the value of the company, such as investing in new projects or returning capital to shareholders through dividends or share buybacks.
What is the main disadvantage of the corporate form? ›
Answer and Explanation:
The main disadvantage of the corporate form of organization is the double taxation of shareholders.
What are the two biggest disadvantages of the corporate? ›
Disadvantages of a Corporation
It is subject to heavier taxation than other forms of business organizations. Minority shareholders are subservient to the wishes of the majority. In large corporations, management and control have been separated from ownership.
What are three advantages of bonds? ›
Pros of Buying Bonds
- Regular Income That's Sometimes Tax-Free. Most bonds have a fixed coupon payment—the interest that bondholders receive—and you'll generally get a coupon payment every six months. ...
- Less Risky Than Stocks. Bonds tend to be less risky than stocks or equity funds. ...
- Relatively High Returns.
Corporate bonds are bonds issued by companies. Companies issue corporate bonds to raise money for a variety of purposes, such as building a new plant, purchasing equipment, or growing the business. Corporate bonds are debt obligations of the issuer—the company that issued the bond.
