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Corporate bonds might sound complex, but they can be a powerful tool for building wealth and creating steady income.
Having considered bonds myself, I know they can feel a bit overwhelming – so I’m here to help you make sense of it all!
In this post, you’ll learn:
- What corporate bonds are and how they work
- The different types of corporate bonds available
- Key risks to be aware of before investing
- What to look out for in Singapore’s bond market
Ready to get started?
Let’s dive in!
What are corporate bonds and how do they work?
Corporate bonds are essentially IOUs issued by companies needing to raise capital.
Think of them as loans you, the investor, provide to a corporation.
Unlike stocks, where you own a piece of the company, bonds don’t give you ownership.
Instead, you’re lending the company money, which they’ll use for specific business needs – whether expanding operations, buying new equipment, or simply keeping things running smoothly.
At the end of the bond’s maturity period, the company repays you the bond’s face value (also called the principal).
Throughout this period, you’ll receive regular interest payments – typically twice a year – based on the bond’s coupon rate, which is the interest rate the company has agreed to pay.
How do I make money from corporate bonds?
Coupon payments
The primary way you earn from corporate bonds is through coupon payments.
These are regular interest payments the company makes, typically twice a year, based on a fixed interest rate set when the bond is issued.
So, if you invest in a bond with a 5% coupon rate and a face value of $1,000, you’ll receive $50 annually in interest payments.
It’s a reliable income stream that you can count on, especially if you prefer investments with predictable returns.
Capital gains
While regular income is the main draw for bond investors, there’s also the possibility of capital gains.
If interest rates drop after you’ve bought a bond, the price of that bond usually rises, allowing you to sell it for a profit.
For example, if you purchased a bond when interest rates were 5%, and rates then fell to 3%, your bond’s fixed 5% interest becomes more attractive, pushing up its market price.
However, it’s important to note that capital gains on bonds are generally modest and not as substantial as gains from stocks.
Why invest in corporate bonds?
Higher yields than government bonds
Unlike government bonds, which are backed by the stability of a government, corporate bonds carry a higher risk – companies don’t have the same financial security as governments.
To compensate, companies offer higher interest rates on their bonds, meaning you earn a better return on your investment compared to typical government bonds.
Steady income
Corporate bonds provide a predictable and steady income through regular coupon payments, which makes them appealing if you prefer a consistent income stream.
This is especially valuable for conservative investors or those in retirement, as you receive regular payments (often semi-annually) without the fluctuations of stock dividends.
This income predictability can be a great way to supplement other investments, especially if you’re after a low-maintenance, income-generating asset.
Diversification
Corporate bonds offer a great way to diversify. If most of your investments are in stocks, adding bonds can provide a stabilising effect.
Stocks and bonds tend to move differently under varying economic conditions, so when the stock market dips, the income from your bonds can help offset some of those losses.
This balance is especially helpful if you’re seeking to reduce the volatility of your portfolio and preserve capital during uncertain times.
Varied risk profiles
One of the best features of corporate bonds is the flexibility they offer.
You can choose bonds across various credit ratings, sectors, and maturities to suit your personal risk and income goals.
For example, investment-grade bonds from established companies come with lower risk and steady, moderate returns.
On the other hand, high-yield or “junk” bonds have higher interest rates to reward the increased risk.
This variety allows you to tailor your bond investments, whether you’re seeking safer, long-term income or are willing to take on more risk for higher potential returns.
What determines the interest rates on bonds?
Credit rating of the issuer
Established by credit rating agencies like Moody’s or S&P, these ratings assess a company’s creditworthiness and the likelihood it will repay its debt.
A higher rating (like AAA) signals lower risk, so these bonds offer lower interest rates.
Conversely, lower-rated or “junk” bonds have higher rates to compensate for the higher risk of default.
Current interest rate environment
The overall market interest rates, often influenced by the central bank’s policies, also play a significant role.
When interest rates are high, newly issued bonds offer higher coupon rates to stay competitive, as investors could otherwise turn to other interest-bearing products like savings accounts.
When rates are low, new bonds tend to offer lower rates.
Time to maturity
Bonds with longer maturity periods generally carry higher interest rates.
This is because lending money for a longer period carries more uncertainty and risk – after all, economic conditions and inflation can change over time.
Shorter-term bonds, on the other hand, tend to have lower rates because they involve less risk over a shorter period.
Economic and industry conditions
The state of the economy and the issuing company’s industry also affect bond rates.
For example, if the economy or a specific industry is struggling, companies in that sector may need to offer higher rates to attract investors.
Conversely, in a stable economic period, companies can often issue bonds at lower rates.
What are some of the risks of corporate bonds?
Credit or default risk
Credit or default risk is the possibility that the issuing company won’t be able to meet its interest payments or repay the bond’s principal at maturity.
This risk level varies widely between companies, so credit ratings exist to help investors gauge it.
Rating agencies like Moody’s and S&P assign these ratings based on an issuer’s financial stability and repayment history.
Interest rate risk
Interest rate risk is the risk that changes in market interest rates will affect bond prices.
When market interest rates rise, bond prices tend to fall – and vice versa.
This is because investors prefer newer bonds that offer higher rates, reducing the appeal of existing bonds with lower rates.
This risk is especially pronounced with long-term bonds, as they’re more sensitive to rate changes than short-term bonds.
For example, if you own a long-term bond with a low coupon rate, rising interest rates can significantly reduce its resale value if you sell it before maturity.
Inflation risk
Inflation risk is the chance that inflation will erode the purchasing power of your bond income over time.
When inflation rises, each dollar you receive in interest payments or principal repayment buys less than it did initially.
This can be particularly troublesome with fixed-rate bonds, as the interest payments remain the same even as prices for goods and services rise.
In periods of high inflation, the real value of your returns diminishes, making it crucial to consider inflation when planning for long-term income from bonds.
Liquidity risk
Liquidity risk refers to the difficulty of selling a bond quickly at a fair market price.
While some bonds trade frequently and have high liquidity, others are traded less often, making them harder to sell at an acceptable price, especially during market downturns.
Unlike stocks, bonds don’t have the same level of pricing transparency, meaning the actual value can be harder to gauge.
This risk is more common with bonds that don’t trade on public exchanges and where the bondholder may be forced to sell in an urgent or unfavourable market situation.
Call risk
Call risk arises with certain bonds that give the issuer the right to “call” or redeem the bond before its maturity date, typically when interest rates fall.
In this case, the company may repay the bond principal (often with a small premium), allowing it to reissue new bonds at a lower interest rate.
While beneficial for the company, this can be a drawback for you, as you may need to reinvest at lower rates, potentially reducing your future income.
It’s essential to check if a bond has any call provisions before investing, as this can significantly affect long-term returns.
What are the different types of corporate bonds?
Investment grade vs. junk bonds
Corporate bonds are classified based on their credit rating, which reflects the issuer’s financial strength and risk of default.
Investment-grade bonds have a rating of BBB or higher, making them relatively safe options with lower yields, as they come from companies with strong credit profiles.
Junk bonds, on the other hand, are rated BB or lower.
These high-yield bonds carry a greater risk of default but offer higher interest rates to compensate for this increased risk.
Secured vs. unsecured
Secured bonds are backed by specific assets or collateral, such as property or equipment, which the company pledges as security.
If the company defaults, these assets can be sold to repay bondholders, offering an extra layer of protection.
Unsecured bonds, also known as debentures, don’t have collateral backing them, meaning repayment depends solely on the company’s creditworthiness.
As a result, unsecured bonds carry more risk, but companies often offer slightly higher interest rates to attract investors.
Callable bonds
Callable bonds, as the name suggests, come with a call feature that allows the issuer to repay the bond before its maturity date, often when interest rates fall.
This gives the issuing company flexibility to refinance its debt at a lower cost, but it can disadvantage you as an investor.
If the bond is called, you receive the principal (and sometimes a premium) but lose the opportunity to continue earning interest at the original rate.
Callable bonds generally offer higher coupon rates to offset this potential downside, but it’s wise to assess whether the call feature aligns with your investment goals.
What should you look out for when investing in corporate bonds in Singapore?
Credit quality of the issuer
The credit quality of a bond issuer is a primary indicator of its reliability and risk.
Companies with high credit ratings (such as AAA or AA) are considered more stable and have a lower risk of default.
High credit quality means lower risk but also typically comes with lower yields.
Yield to maturity (YTM)
Yield to maturity (YTM) represents the total return you can expect if you hold the bond until it matures.
YTM considers the bond’s current market price, coupon payments, and the time left until maturity.
It’s a valuable measure because it gives you a complete picture of your potential earnings, assuming you don’t sell the bond early.
Duration
Duration measures a bond’s sensitivity to interest rate changes, often expressed in years.
Bonds with longer durations are more sensitive to interest rate fluctuations, meaning their prices rise or fall more significantly with rate changes.
In a rising interest rate environment, longer-duration bonds can lose value more quickly than shorter-duration bonds.
Interest rate environment
Interest rates have a direct impact on bond prices.
When interest rates rise, bond prices typically fall, and when rates drop, bond prices generally increase.
Understanding the current and anticipated interest rate environment is crucial, especially if you plan to sell bonds before they mature.
Liquidity
Liquidity refers to how easily you can buy or sell a bond without affecting its price.
Bonds that are frequently traded and in high demand generally offer better liquidity, making it easier for you to sell them at a fair price if needed.
However, some corporate bonds may have lower liquidity, especially those not traded on exchanges.
This can pose a challenge if you need to sell quickly or during a market downturn.
Investment horizon and objectives
Your investment horizon – the time you plan to hold your bonds – should align with your financial objectives.
For short-term goals, shorter-maturity bonds may be preferable as they carry less interest rate risk.
On the other hand, if you’re investing for long-term income or stability, longer-term bonds might be a better fit.
Think about your cash flow needs, risk tolerance, and overall goals before selecting bonds.
Currency risk
Currency risk arises when you invest in bonds denominated in a currency other than the Singapore dollar (SGD).
Fluctuations in exchange rates can impact the value of your returns.
For example, if the SGD strengthens against the currency in which the bond is issued, your returns in SGD will be lower when converted.
Singaporean investors may face this risk with international corporate bonds or foreign-currency-denominated bonds.
Who should invest in corporate bonds?
Risk-averse investors
If you’re someone who values stability and wants to avoid the unpredictable swings of the stock market, corporate bonds could be a great fit.
Bonds generally offer less volatility than stocks, which makes them appealing to risk-averse investors looking for moderate, steady returns.
Investment-grade corporate bonds, in particular, provide a safer option than high-yield or “junk” bonds, as they’re issued by financially strong companies.
Income seekers
Corporate bonds are also a popular choice for income-focused investors, thanks to their regular coupon payments.
These semi-annual payments offer a predictable income stream, which can be especially valuable if you’re retired or aiming for a steady cash flow to supplement your earnings.
The income is fixed and generally higher than what you’d earn from government bonds, making corporate bonds an attractive option if you want consistent returns without constantly monitoring the market.
Diversifiers
If you’re building a diversified portfolio, corporate bonds can add a layer of stability and balance to your investments.
Bonds typically behave differently from stocks, meaning that when stock prices fall, bond prices may remain steady or even increase.
This offsetting effect can help smooth out your portfolio’s performance, making corporate bonds a valuable addition for investors seeking a balanced mix of growth and income.
Adding corporate bonds to a portfolio of stocks or other high-risk assets can reduce overall risk and provide a cushion during market downturns.
Frequently Asked Questions
Do corporate bonds pay monthly?
Corporate bonds generally do not pay monthly.
Instead, corporate bondholders typically receive interest payments semi-annually, or every 6 months.
The exact schedule, however, is set by the bond’s terms, so it’s essential to review the payment frequency before investing.
When does a bond default?
A bond defaults when the issuing company fails to make scheduled interest payments or repay the principal at maturity.
Default typically happens if the issuer faces financial difficulties or lacks sufficient cash flow.
Credit ratings and financial health indicators can provide insight into a bond’s default risk.
Conclusion
Corporate bonds can be a solid investment if you’re after higher returns than government bonds, have steady income through regular interest payments, and have a way to balance out your portfolio.
We’ve looked at corporate bonds, how they work, and the types available, from investment-grade to junk bonds, secured to unsecured options.
You also know the risks involved, like credit, interest rate, and inflation risks, and key factors to consider before investing, such as credit quality and duration.
If you’re unsure or want to dig deeper, don’t stress – investing in bonds can be a lot to take in.
Our trusted financial advisor partners are here to help, and you can chat with them for free to get personalised guidance.
With the right information, corporate bonds could become a valuable part of your financial strategy.
