A corporate bond is a type of fixed-income security issued by corporations to raise capital for business operations, expansion or other financial needs. When investors buy corporate bonds, they are effectively lending money to the issuing company. In return, the company agrees to pay the investor a specified rate of interest at regular intervals, typically semi-annually, and to return the principal amount, also known as the face value, on a predetermined maturity date. The interest rate, or coupon rate, reflects the credit risk associated with the issuing corporation; higher-risk companies often offer higher interest rates to attract investors.
The significance of corporate bonds for investors lies in their potential to provide a steady income stream through interest payments, making them an attractive option for income-focused investors. Corporate bonds typically offer higher yields than government bonds or savings accounts, compensating for the higher risk of lending to businesses as opposed to government entities. These bonds also add diversification to an investment portfolio, potentially reducing overall risk when combined with other types of investments such as stocks and government bonds.
However, investing in corporate bonds carries risks, including credit risk, interest rate risk and liquidity risk. Credit risk pertains to the possibility that the issuing company might default on its interest payments or fail to return the principal at maturity. Interest rate risk arises from fluctuations in market interest rates; as rates rise, the value of existing bonds with lower coupon rates typically falls. Liquidity risk refers to the ease with which bonds can be bought or sold in the market without significantly affecting their price. To mitigate these risks, investors often assess the credit ratings of corporate bonds, issued by credit rating agencies, which provide an indication of the issuer's financial strength and ability to meet its obligations.
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