Investment Made Easy
Many companies raise money to invest in their operations by selling corporate bonds. Bonds have a face value such as £1,000, which the organisation must return to the investor at the end of the maturity period, such as five, ten years or 30 years. The attraction in corporate bonds lies in the fixed interest rate the company pays the investor monthly, quarterly or annually.
For example, an individual invests £20,000 in a five-year bond with a five percent return, receives £1000 a year in interest. The company returns the principal at the end of the five-year redemption period.
Most investors purchase corporate bonds through bond funds. The fund manager evaluates the companies and spreads investments across multiple funds. This approach distributes risks associated with investing in corporate bonds – interest rate, liquidity, supply, inflation and taxes. Fund investors pay an annual fee to the fund manager.
The value of a corporate bond fund hinges on the holdings at a particular point in time. If an investor purchases shares as interest rates trend up, the value of bonds held in the fund declines. Spreading investments across numerous company bonds lessens the financial affects on individual fund investors if a firm goes out of business.
The other method for investing in bonds consists of purchasing bonds issued by individual companies. The individual investor must conduct the necessary research. This strategy – investing in the bond of a single company – increases risk to the investor. If the investor holds the bond through the maturity date, the firm returns the money. If the firm defaults, the investor loses the money.
The interest rates investors receive on corporate bonds depends on a variety of factors, including current interest rates, whether rates rise or fall, the credit rating of the bond and the issuing company’s stability
Corporate bonds receive a rating from the credit rating agencies—Moody’s or Standard & Poor’s. Each agency has its own rating system. “Investment-grade bonds” rates from prime (AAA) to lower medium grade (AA, A, BBB-.) Investment-grade bonds pay lower interest rates, but offer capital safety.
“Junk bonds” have ratings of BB, Ba or less. The financial markets consider these bonds speculative because of the increase risk of company defaults. Companies issuing junk bonds pay higher interest to entice investors.
With historic low interest rates and market volatility, investors seek investments that provide a reasonable rate of return and capital protection. Consequently, investing in an investment-grade corporate bond, at a 5.2 percent return, proves more attractive than a savings account offering a two percent rate of return. It also eliminates the risk incurred in buying individual shares or an equity fund.