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Charles J. Corrado_Fundamentals of Investments - Chapter 11

CHAPTER 11 Corporate Bonds A corporation issues bonds intending to meet all required payments of interest and repayment of principal. Investors buy bonds believing that the corporation intends to fulfill its debt obligation in a timely manner. Although defaults can and do occur | CHAPTER 11 Corporate Bonds A corporation issues bonds intending to meet all required payments of interest and repayment of principal. Investors buy bonds believing that the corporation intends to fulfill its debt obligation in a timely manner. Although defaults can and do occur the market for corporate bonds exists only because corporations are able to convince investors of their original intent to avoid default. Reaching this state of trust is not a trivial process and it normally requires elaborate contractual arrangements. Almost all corporations issue notes and bonds to raise money to finance investment projects. Indeed for many corporations the value of notes and bonds outstanding can exceed the value of common stock shares outstanding. Nevertheless most investors do not think of corporate bonds when they think about investing. This is because corporate bonds represent specialized investment instruments which are usually bought by financial institutions like insurance companies and pension funds. For professional money managers at these institutions a knowledge of corporate bonds is absolutely essential. This chapter introduces you to the specialized knowledge that these money managers possess. 11.1 Corporate Bond Basics Corporate bonds represent the debt of a corporation owed to its bondholders. More specifically a corporate bond is a security issued by a corporation that represents a promise to pay to its bondholders a fixed sum of money at a future maturity date along with periodic payments of 2 Chapter 11 interest. The fixed sum paid at maturity is the bond s principal also called its par or face value. The periodic interest payments are called coupons. From an investor s point of view corporate bonds represent an investment quite distinct from common stock. The three most fundamental differences are these 1. Common stock represents an ownership claim on the corporation whereas bonds represent a creditor s claim on the corporation. 2. Promised cash flows -