Investing in corporate bonds
Corporate bonds are issued by companies seeking to raise capital. In return for the loan of your capital, you will receive a level of interest (known as the coupon) as a regular income for a given period of time. The capital you invest (known as the nominal value) will usually be returned to you when the bond reaches maturity.
How corporate bonds work
Corporate bonds work in a broadly similar way to government bonds, also known as gilts, except that you are loaning your capital to a company rather than to a government. Corporate bonds are generally more risky than government bonds, as the government is considered less likely to default on their debt than a company.
When you invest in corporate bonds your capital – and the interest – are not guaranteed. This means that you could end up losing some or all of what you put in if the company you are invested in goes bust. Checking a company's credit rating can help you to assess the level of risk involved, but credit history can't be taken as an exact indicator of future performance.
Generally, the longer the term of the bond and the greater the perceived risk involved, the higher the coupon (or interest rate) will be.
Corporate bonds are generally considered less risky than investing in shares, and should a company get into financial difficulty, bondholders will have priority over shareholders when it comes to potential repayment.
Corporate bonds are issued in units, normally £100 in value. The amount they are issued for is their "nominal value". Corporate bonds are often traded on the stock market, where their price can fluctuate according to demand and the solvency of the issuer. While the nominal value may be £100, the amount that you purchase the bond for on the stock market could be above or below this amount. Regardless of the amount that you purchase the bond for, the nominal value is what you will receive when the bond matures, provided the company that you’re investing in doesn’t go bust.
The coupon you receive will be calculated according to the nominal value rather than how much you paid for the bond. So for example, if you bought a bond with a nominal value of £100 and a coupon of 5%, but only paid £90 for it on the stock market, the interest you receive would be would be 5% of £100 (£5). So the interest rate on the £90 you paid would be closer to 5.55% of your actual capital outlay.
Corporate bond funds
You can invest in corporate bonds through a stockbroker, or through a corporate bond investment fund.
When you invest through a corporate bond investment fund, such as certain types of OEICs or Unit Trusts, your money is pooled with that of other investors, and invested on your behalf by a fund manager into a variety of bonds. Investing through a fund can help you spread your investment over a wider range of companies. This can reduce certain types of investment risk, because if one company should go bust you will not necessarily lose all of your capital.
If you decide that investing in corporate bond funds is right for you, you can do so through a platform such as Hargreaves Lansdown, or you can speak to a financial adviser for bespoke advice on choosing a fund.
Last updated: 18 May 2015