How does investing with corporate bonds work?
Companies must constantly develop and need fresh capital for their investments. One way of obtaining outside capital is through so-called debt securities or corporate bonds. For investors, corporate bonds are a financial product for investment similar to government bonds: they provide companies with capital and receive interest in return. Unlike shares, corporate bonds have a fixed interest rate and a fixed term.
Why do companies issue bonds?
Corporate bonds have been around for hundreds of years. If a company wants to expand, develop new business areas, make major investments, carry out research, develop new products or ensure liquidity, it must raise capital. Corporate bonds enable companies to borrow money from private investors. Bank loans often involve extensive checks and are subject to conditions. Corporate bonds can be a useful alternative or supplement for companies.
What is the difference between a bond and a share?
If a large company wants to raise capital, it can convert to a public company and issue listed shares. The purchasers of these shares, the shareholders, become co-owners of the company and thus have a say in the company. The company must therefore give up some of its entrepreneurial freedom. When raising capital through a bond issue, the company does not need to change legal form. The investors will not become co-owners and the company will remain autonomous in its decisions.
For investors there is also a big difference between corporate bonds and shares. Ratings from agencies give investors the opportunity to assess the creditworthiness of the company. In contrast to buying shares, however, investors do not benefit from the success of the company in the form of price increases of the stocks or dividends - they only receive the previously agreed interest. However, they are entitled to this interest, while shares can also suffer price losses or the dividends can be reduced or cancelled.
How can you buy corporate bonds?
To buy corporate bonds, you need a bank deposit. You can easily open one online. The bonds can be bought from a broker. As with equity funds, corporate bonds incur various costs, such as transaction costs when buying or selling on the stock exchange and brokerage fees. In addition to buying individual corporate bonds, investors can also invest in funds that divide the money between different bonds.
What are the advantages of bonds for investors?
Compared to shares, bonds have the advantage that they have a fixed interest rate, which means that they can generate relatively secure returns. Investors need not fear price fluctuations, as is the case with shares.
What disadvantages do corporate bonds have for investors?
Corporate bonds have several disadvantages for investors:
Risks: If the issuer becomes insolvent, there is a risk of total loss of the capital invested. In addition, companies can try to negotiate the firmly guaranteed interest rates afterwards in the event of a financial imbalance. Individual corporate bonds are therefore usually riskier for private investors than government bonds, for example. Investors should therefore pay particular attention to the issuer's rating and reserves.
Transparency: Bond terms and conditions are often difficult to understand, especially for investors with little previous experience. The term, repayment, interest rate, collateral, creditor protection clauses and termination rights of bonds should be examined.
Yields: High yields usually correlate with high risk. Above-average returns can usually be achieved by bonds issued by companies with poorer credit ratings. However, the risk is also particularly high for these companies. More security is offered by a fund that invests the capital more broadly in various bonds and reduces the risk through diversification.
Minimum investment amounts: The minimum investment amounts for bonds are relatively high. Investors often have to reckon with a minimum investment of 1,000 euros, so a relatively large amount of capital would be necessary to achieve an appropriate spread of risk.