Corporate bonds are issued as a way of raising money for businesses - it's essentially a certificate of debt issued by major companies When you buy bonds you are lending money to a company in exchange for an IOU. The IOU has a term and at maturity (typically five or ten years) the sum invested is returned in full.
The only thing that might stop this is if the company actually goes bust. The bond also has a coupon - the amount of interest paid, say 5 per cent.
As long as you hold that bond you are paid that coupon every year and if you keep it to maturity you will get your capital back. Crucially, the coupon is a fixed percentage of the cover price of the bond.
So if you buy a £10,000 ten year bond with a 5% return, you will receive £500 each year in interest, and after ten years you will get your £10,000 back.
So far this is not so different from a fixed-rate savings account or savings bond, except your bond is an investment and not a savings product, so it is not covered by the Financial Services Compensation Scheme £85,000 individual savings protection cover. Crucially, this means that your bond is only as safe as the company issuing it - something reflected in smaller, more risky firms having to offer higher rates to tempt investors.
But you can get out early The key difference in flexibility between a corporate bond and fixed rate savings is that during its lifetime a market-traded corporate bond can be bought and sold and its price will change according to the market.
So if you hold a ten-year corporate bond you personally don't have to wait ten years to cash-in the bond - you could sell it at any point.
But if you do want to sell it on, between its issue and maturity date the bond's price will rise and fall and at any given moment it may be worth less than you paid for it, perhaps you would only get £95 for every £100 you invested.
On the other hand it may be worth more and you will be able to make a capital gain on the investment as well.
When bonds are trading above or below their initial level they are said to be trading above or below par. If you buy a corporate bond second-hand, you will get the right to be repaid its value at maturity and its coupon interest rate until then, but paying above or below par for the bond itself will change the income return.
This means that with traded second-hand bonds a yield to maturity is also typically quoted. If you buy at a discount your yield to maturity will be higher than the original coupon rate, if you buy above par it will be lower.
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