Corporate bonds are used by many companies to raise funding for large-scale projects - such as business expansion, takeovers, new premises or product development. They can be used to replace bank finance, or to provide long-term working capital.
The main features of a corporate bond are:
- the nominal value - the price at which the bonds are first sold on the market
- the interest rate paid to the bond owner - this is usually fixed
- the redemption date - when the nominal value of the bond must be repaid to the bond holder
Bonds can be sold on the open market to investment institutions or individual investors, or they can be placed privately. For more information, see advantages and disadvantages of raising finance through private placements.
If bonds are sold on the public market, they can be traded - similar to shares. Some corporate bonds are structured to be convertible, which means they can be exchanged for shares at some point in the future.
Advantages of issuing corporate bonds
Bonds can be a very flexible way of raising debt capital. They can be secured or unsecured, and you can decide what priority they take over other debts. They can also offer a way of stabilising your company's finances by having substantial debts on a fixed-rate interest. This offers some protection against variable interest rates or economic changes.
Other advantages of using bonds to raise long-term finance include:
- not diluting the value of existing shareholdings - unlike issuing additional shares
- enabling more cash to be retained in the business - because the redemption date for bonds can be several years after the issue date
Disadvantage of issuing corporate bonds
There are also some disadvantages to issuing bonds, including:
- regular interest payments to bondholders - though interest may be fixed, the interest will usually have to be paid even if you make a loss
- the potential for your business' share value to be reduced if your profits decline - this is because bond interest payments take precedence over dividends
- bondholder restrictions - because investors are locking up their money for a potentially long period of time, they can impose certain covenants or undertakings on your business operations and financial performance to limit their risk
- ongoing contact with investors can be somewhat limited so changes to terms and conditions or waivers can be more difficult to obtain compared to dealing with bank lenders, who tend to maintain a closer relationship
- having to comply with various listing rules in order to increase the tradability of the bonds listed on an exchange - particularly, an obligation to make information on the company publicly available at the issue stage and regularly during the life of the bond
Additionally, although it isn't a mandatory requirement, having a credit rating can help you launch a successful bond issue. However, this is time consuming and will be an added cost to issuing the bonds.
FAQs
Bonds have some advantages over stocks, including relatively low volatility, high liquidity, legal protection, and various term structures. However, bonds are subject to interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.
What are the advantages and disadvantages of issuing corporate bonds? ›
Bonds have some advantages over stocks, including relatively low volatility, high liquidity, legal protection, and various term structures. However, bonds are subject to interest rate risk, prepayment risk, credit risk, reinvestment risk, and liquidity risk.
What are some advantages and disadvantages of investing in bonds? ›
Types of bonds: Advantages and disadvantages
- Advantages: Safety and low risk, thanks to backing of U.S. government.
- Disadvantages: Limited growth potential and prices will fall if rates rise.
Bonds can be a very flexible way of raising debt capital. They can be secured or unsecured, and you can decide what priority they take over other debts. They can also offer a way of stabilising your company's finances by having substantial debts on a fixed-rate interest.
Which of the following is a disadvantage to a corporation issuing bonds? ›
Disadvantages of Corporate Bonds
Credit risk is a disadvantage of corporate bonds. If the issuer goes out of business, the investor may never get the promised interest payments or even get their principal back.
What are the risks of issuing corporate bonds? ›
Risk Considerations: The primary risks associated with corporate bonds are credit risk, interest rate risk, and market risk. In addition, some corporate bonds can be called for redemption by the issuer and have their principal repaid prior to the maturity date.
What are the disadvantages of bond funds? ›
The disadvantages of bond funds include higher management fees, the uncertainty created with tax bills, and exposure to interest rate changes.
Are corporate bonds a good investment right now? ›
Overall, we expect corporate bonds to deliver positive returns in 2024, but we remain cautious about the potential for a downturn in the economy to have a negative impact on lower-rated bonds.
Why are corporate bonds important? ›
Corporate bonds are a form of debt financing. They are a major source of capital for many businesses, along with equity, bank loans, and lines of credit. They often are issued to provide the ready cash for a particular project the company wants to undertake.
What is a disadvantage of bond financing? ›
A disadvantage of financing through bonds is the issuing company will pay periodic interest and its par value at maturity, so it is required to accumulate funds to pay these obligations, unlike equity financing, which pays dividends when the firm has enough funds.
What disadvantage do bonds present for the issuer? If the firm does not do well financially the bond can be downgraded. To transfer money between savers and borrowers, allowing investment to take place, an economy needs a(n)... Financial assets.
Which of the following is a disadvantage of bond financing Quizlet? ›
Which of the following is a disadvantage of bond financing? Bonds require payment of periodic interest and the par value.
What are the major disadvantages of issuing bonds? ›
Bonds do have some disadvantages: they are debt and can hurt a highly leveraged company, the corporation must pay the interest and principal when they are due, and the bondholders have a preference over shareholders upon liquidation.
What is an advantage of issuing bonds? ›
Earnings per share may be higher. Bonds don't require payment of dividends. Bond prices do not fluctuate as much as stock. An advantage of issuing bonds instead of issuing common stock is that the return on common stockholders ' equity may be higher after bonds are issued.
Which is an advantage of investing in bonds? ›
Bonds tend to be less volatile and less risky than stocks, and when held to maturity can offer more stable and consistent returns. Interest rates on bonds often tend to be higher than savings rates at banks, on CDs, or in money market accounts.
Which of the following is an advantage of issuing bonds? ›
One advantage of issuing bonds instead of stock is that: Multiple Choice Interest rates are lower than dividend rates. Bonds have a longer maturity date. Borrowing funds by issuing bonds does not affect earnings per share. Interest is tax deductible, whereas dividends are not.
What are the advantages and disadvantages of issuing preferred stock versus bonds? ›
Bonds offer investors regular interest payments, while preferred stocks pay set dividends. Both bonds and preferred stocks are sensitive to interest rates, rising when they fall and vice versa. If a company declares bankruptcy and must shut down, bondholders are paid back first, ahead of preferred shareholders.
What are the advantages and disadvantages of rights issue? ›
The main advantage of the rights issue is that It gives existing shareholders the exclusive right to purchase additional shares at a predetermined price. However, potential disadvantages include dilution of ownership for non-participating shareholders and market distrust, which could lead to a decrease in stock value.
