Buying corporate bonds: A beginner's guide

Corporate bonds are debt instruments that companies use to gather funds. They have become an increasingly popular choice for traders, primarily because of their potential to yield higher returns compared to some other bonds, like government or municipal bonds.

In this guide, learn the reasons why corporate bonds are attractive for investors and traders, explore the markets for buying them, and discuss the strategies for evaluating their worth.

Why should one consider buying corporate bonds?

1. Potential for attractive yields than other financial assets

When you decide to buy corporate bonds, you’re essentially lending money to companies in exchange for periodic interest payments and the return of the bond’s face value when it matures.

Historically, corporate bonds offer better yields than safer investment options like government securities. This is because companies are riskier than governments, so they offer higher yields to compensate for the higher risk. The yield is the percentage return you earn on your investment. Thus, the higher the yield, the greater the potential return on investment.

2. Regular return through interest payments

A primary reason to buy corporate bonds lies in the stable revenue they generate. Unlike stocks, which may or may not distribute company dividends, corporate bonds promise periodic interest payments.

These are often paid semi-annually, providing bondholders with a consistent income stream. So, if you buy corporate bonds, you’re ensuring a more predictable revenue compared to some volatile investments.

3. Credit ratings and their implications for risk and return

You don’t need to worry about scams or determining the best corporate bonds to trade. Credit rating agencies assign ratings based on issuers’ ability to meet financial commitments. A higher rating typically means a lower risk of default.

Before you buy corporate bonds, understanding these ratings is essential. Higher-rated bonds (like AAA) are deemed safer but offer lower yields. Conversely, lower-rated bonds present higher yields but come with greater risk.

Therefore, when you buy corporate bonds, be informed of their credit ratings, as they can be instrumental in gauging risk versus reward.

4. Diversification benefits

When you buy corporate bonds, you add a different asset to your portfolio, helping spread the risk. While stocks represent company ownership, bonds are loans you make to the company. The performance of bonds often contrasts with that of equities, meaning when stocks are down, bonds might be up, providing a balance in one’s portfolio.

Where to buy corporate bonds?

With technological advancement, corporate bonds can now be bought online through various platforms rather than exclusively from companies or financial markets. Here are some markets you can consider buying them from.

Primary markets: New bond issues

If you’re wondering how to buy corporate bonds fresh from issuers, then the primary market is your destination. The primary market serves as the original venue for securities issuance. It is the birthplace of new securities, where corporations and governments raise capital directly from investors.

Trading in the primary market has its unique advantages:

• Initial pricing: When you buy corporate bonds in the primary market, you usually get them at their initial offering price, which is typically the bond’s face value. This is advantageous, especially if the bond becomes highly sought-after in the secondary market, leading to price appreciation.
• Direct relationship: Purchasing directly in the primary market often means you have a direct contractual relationship with the issuer, ensuring clarity regarding rights and obligations.
• Exclusive opportunities: Sometimes, unique bond offerings with special terms or benefits are available only in the primary market and may not be as readily available in the secondary market.

Secondary markets: Buying previously issued bonds

The secondary market, often likened to a bustling marketplace for securities, stands in contrast to the primary market, where bonds are made.

In the secondary market, investors trade securities they previously bought with no involvement of the issuing companies. This market becomes the central place for those who want to buy corporate bonds after their initial issuance.

Over-the-counter (OTC): Popular marketplace for online traders

The OTC market isn’t restricted to a physical location or a central trading system. Instead, it is a network of dealers and brokers who negotiate directly with each other. When you want to buy corporate bonds via OTC, you’re typically dealing with a broker or dealer rather than placing an order on a primary exchange.

You can trade corporate bonds on the leading contract for difference (CFD) trading platform, markets.com. Here, you’ll obtain access to a diverse range of securities, making buying and selling a seamless experience.

Directly from companies: Rare but possible

Occasionally, corporations allow individual investors to buy corporate bonds directly from them without intermediaries. This method is rare, but if you can find such opportunities to buy corporate bonds, it might come with lower fees and more straightforward transactions. Always ensure you’re well informed and thoroughly researched before taking this route.

How to evaluate corporate bonds

A careful evaluation ensures that your investment aligns with your risk tolerance, financial goals, and broader market conditions. Here are the factors and tools to consider when appraising corporate bonds.

Agencies and their grading system

Credit ratings play an indispensable role when you want to buy corporate bonds. These ratings, provided by established rating agencies like Moody’s, S&P, and Fitch, offer insights into the creditworthiness of a bond issuer. Essentially, they gauge the issuer’s ability to meet its financial obligations, especially the timely repayment of interest and principal.

A bond that boasts a high rating, such as AAA or AA, is seen as top-tier in terms of creditworthiness. These ratings signal a strong financial standing of the issuer and, consequently, a lower risk of default. Investors often consider such bonds as “safe havens” for their capital, especially in volatile markets.

Conversely, bonds with lower ratings are often termed junk or speculative-grade bonds. These bonds offer attractive yields for the increased risk they carry. While they might present an opportunity for significant returns, the accompanying risk is that the issuer might face financial hardships or even default on their obligations.

You might also like to read: What is a forex CFDs broker?

Analysing a company’s financial health

While credit ratings are insightful, it’s equally imperative to independently assess a company’s financial health before you buy corporate bonds. Company documents, like balance sheets, income statements, and cash flow statements, provide a window into the company’s financial stability. Look for consistent profitability, manageable levels of debt, and strong cash reserves. Such factors give confidence in the company’s capacity to honour its bond obligations.

Yield to maturity (YTM)

Yield to maturity represents the total return you can expect if you hold the bond until it matures. Unlike simple bond yields, which only consider annual interest payments, YTM accounts for the bond’s current price, face value, interest payments, and the time until maturity.

This metric provides a more precise portrayal of the potential profitability of a bond, aiding you in making more informed choices when you buy corporate bonds

Aside from using YTM as a metric for bond yields, you can also use markets.com’s CFD Trading Calculator to calculate your hypothetical P/L (aggregated cost and charges).

Using our calculator, you can easily evaluate any position you hold or are about to open by calculating its spread, margin requirement, overnight swap and more.

Role of covenants as protection for bondholders

Covenants act as a safety net, ensuring that the bond issuer remains committed to maintaining a certain financial health and stability, which, in turn, minimises the risk to the bondholder. They provide investors with assurance, knowing that specific rules and stipulations bind the issuer.

For instance, a covenant might mandate regular financial disclosures, allowing bondholders to monitor the company’s fiscal health. Another might limit the issuer’s ability to pay dividends until bondholders are paid. These covenants testify to the bond issuer’s commitment to obligations and are a tool for bondholders to safeguard their investments.

To wrap up

Corporate bonds present a unique investment opportunity for aspiring investors and traders. These bonds offer the potential for attractive yields, particularly compared to other financial assets. Moreover, they provide investors with recurring income, diversification benefits, and a degree of security through credit ratings and covenants.

However, like any investment, it’s important to approach corporate bonds with a keen understanding of the primary and secondary markets, the complexities of over-the-counter trading, and the importance of thoroughly evaluating the bond’s worth.

Whether you’re drawn to the reliability of high-rated bonds or the potential rewards of riskier options, it’s imperative to be well-informed.

Buy corporate bonds and other financial assets at markets.com

You can trade corporate bonds on markets.com through CFD trading. In this type of trading, you will be speculating the price of your chosen bonds without having an actual asset.

Aside from corporate bonds, markets.com offers various popular assets, including Forex, shares, commodities, indices, cryptocurrencies, exchange-traded funds (ETFs), and IPO CFDs.

With an extensive selection and user-friendly interface, our trading platform caters to beginners and seasoned traders. It’s designed to equip you with all the necessary tools and resources, ensuring a seamless trading experience regardless of your preferred asset class.

Ready to trade with markets.com? Creating an account is easy!

When considering “CFD corporate bonds” for trading and price predictions, remember that trading CFDs involves a significant degree of risk and could result in capital loss. Past performance is not indicative of any future results. This information is provided for informative purposes only and should not be construed to be investment advice.”