Yield
Corporate bonds usually offer higher yields than government bonds or certificates of deposit, reflecting higher risk.
Understanding investment types
Corporate bonds
Corporate bonds are debt obligations issued by corporations to raise capital and operating cash. Investors lend money to the issuing corporation in exchange for periodic interest payments and repayment of principal at maturity. Unlike stockholders, bondholders have no ownership in the corporation. Corporate bonds usually are issued in $1,000 or $5,000 denominations.
Credit rating
Many corporate bonds are rated by agencies such as Moody's Investors Service and Standard & Poor's Corporation. Ratings reflect the agencies' assessment of the creditworthiness of the issuer and its ability to make timely payments of principal and interest.
Moody's and S&P focus on an issuer's financial condition and credit history.
- On the Moody’s rating scale, issues rated Baa3 or above are generally considered to be investment-grade, while those rated lower than Baa3 are generally considered to be below investment-grade.
- On the S&P rating scale, issues rated BBB– or above are generally considered to be investment-grade, while those rated lower than BBB– are generally considered to be below investment-grade.
Disclosures
Issuers disclose information about bond issues and details of their financial condition in a prospectus filed with the Securities and Exchange Commission. The prospectus, along with other continuing financial disclosures, can be found in the SEC's EDGAR database.
Types of corporate bonds
Fixed-rate bonds are issued with an interest rate that doesn't change over the life of the bond.
Floating-rate bonds have variable interest rates that adjust periodically over the life of the bond based on a predetermined formula or a benchmark index.
Zero coupon bonds pay no periodic interest. The bonds are purchased at a discount and redeemed for the full face value at maturity. Generally, investors must pay income tax on interest accrued annually on zero coupon bonds even though no cash interest payments are received. Investors should consult a tax professional for additional information.
Convertible bonds may be converted into shares of another security—usually common stock—under certain terms stated in the indenture.
High-yield bonds are rated below investment-grade. Bonds rated below investment-grade are generally considered to carry a greater degree of risk than investment-grade bonds. This could subject you to greater price volatility and liquidity risk than investment-grade bonds, and in the event of a default, you may not recover your initial investment or any interest owed to you. The two primary independent rating agencies, Moody's and S&P, assign credit ratings to reflect their opinions about the issuer's financial condition and relative credit risk, and aren't guarantees of credit quality or future credit risk. Ratings are subject to change at any time.
Liquidity
Vanguard Brokerage Services® doesn't make a market in corporate bonds. If you want to sell your corporate bonds prior to maturity, Vanguard Brokerage can provide access to a secondary over-the-counter market. The large market size for outstanding corporate bonds generally provides liquidity, but liquidity will vary depending on a bond’s features, credit rating, lot size, and other market conditions.
Taxability
The interest income on corporate bonds is subject to federal, state, and local taxes.
Corporate bonds, when purchased at a discount, may subject investors to capital gains taxes when sold or redeemed. Investors should consult a tax professional for additional information.
Fees
On new issue corporate bonds purchased in the primary market, Vanguard Brokerage may receive a concession from the issuer. If a concession isn't available, Vanguard Brokerage reserves the right to charge a commission. Commissions will be charged for transactions in the secondary market.
Risks
Corporate bond prices can rise or fall depending on interest rates. Interest rate changes generally have a greater effect on long-term bond prices.
All corporate bonds carry the credit risk that the issuer will default or will be unable to make timely payments of interest and principal. Generally, lower-rated bonds carry more credit risk.
Some corporate bonds have call provisions, that allow the issuer to redeem the bonds prior to the stated maturity date. Issuers typically call bonds during periods of declining interest rates.
Some corporate bonds have sinking fund provisions, which require the issuer to periodically retire a predetermined number of bonds.
Some corporate bonds have a "make whole" call provision, which allows the issuer to redeem the outstanding bonds prior to maturity at a price determined by a formula described in the prospectus.
Certain events can impact an issuer's financial situation and ability to make timely payments to bondholders, including economic, political, legal, or regulatory changes and natural disasters. Event risk is unpredictable and can significantly impact bondholders.
Corporate bonds sold prior to maturity may be subject to substantial gain or loss. The secondary market may also be limited.
All investing is subject to risk, including possible loss of principal. High-yield bonds generally have medium- and lower-range credit quality ratings and are therefore subject to a higher level of credit risk than bonds with higher credit quality ratings.