SEC Investor Bulletin: What Are Corporate Bonds?
The SEC's Office of Investor Education and Advocacy issued an Investor Bulletin regarding corporate bonds. A corporate bond, which makes up one of the largest components of the U.S. bond market, is a debt obligation in which the investors purchasing the bond are lending money to the company issuing the bond. In return, the company makes a legal commitment to pay interest on the principal and to return the principle when the bond comes due, or matures. Bonds are classified according to their maturity, or the date the company has to pay back the principle to investors. Maturities can be short term (less than three years), medium term (4 to 10 years), or long term (more than 10 years). Companies use the proceeds from bond sales for variety of purposes, including buying equipment, investing in research and development, and financing mergers and acquisitions.
Like all investments, corporate bonds carry risks. One major risk to bondholders is that the company may fail to make timely payments of interest or principle. If that happens, the company will default on its bonds and may go bankrupt. Other types of risks include interest rate risk, inflation risk, liquidity risk, and call risk. Investors can reduce their risks by diversifying their assets and researching bond fund investments by reading prospectuses, which describe the terms of the bond, significant risks of investing, the financial condition of the company, and how the company plans to use the proceeds from the bond sale.