Definition of a Corporate bond
A bond is just an organization's
promise to repay a sum of money at a certain
interest rate and over a certain period of time,
they also pay a fixed rate of for a fixed period
of time.
But why do organizations issue
bonds? Let's say a corporation needs to build a
new operation building, or to buy a fleet of
vehicles. Or maybe a city government needs to
construct a hospital, repair sewers, or renovate
the sewers. The money generated by the bonds
will serve those expenses.
Corporate bonds are issued by companies of small
and large size. Bondholders are not owners of
the corporation like the shareholders. But if
the company gets in financial trouble and needs
to dissolve, bondholders must be paid off in
full before stockholders get anything. If the
corporation defaults on any bond payment, any
bondholder can go into bankruptcy court and
request the corporation be placed in bankruptcy.
A bond with a maturity of less than two years is
generally considered a short-term instrument and
also known as a short-term note. A medium-term
note is a bond with a maturity between two and
ten years. And of course, a long-term note
would be one with a maturity longer than ten
years.
The price of a bond is a function of prevailing interest rates.
When rates go up, the price of the bond goes
down because that particular bond becomes less
attractive because it pays less interest
compared to current offerings. As rates go
down, the price of the bond goes up, because
that particular bond becomes more attractive
because it pays more interest. The price also
varies in response to the risk perceived for the
debt of the organization. For example, if a
company is in bankruptcy, the price of that
company's bonds will be low because there is a
considerable doubt that the company will ever be
able to pay off the bonds at the end of their
respective terms.
In
the U.S., corporate bonds are generally issued
in units of $1,000.