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Corporate bonds are issued by corporations to raise money. The company borrows because they may want to build a new plant, buy another company, hire employees, or in a tough economic environment, meet immediate fiscal needs. The coupon, or interest rate offered on a corporate bond depends on a number of factors. The federal prime rate is a starting point. The time period for the bond is significant. There is less risk in short-term bonds. There is a lot more risk to a bond maturing 20 years into an unknown future than a bond maturing into three or five years. The most important factor is often the company’s financial stability and rating received from the three standard rating agencies: Standard & Poor’s Rating Services, Moody’s Investors Service and Fitch Ratings. Investors demand a higher rate if they believe there is risk the company cannot meet their debt obligations.
A high-yield debt instrument means the bond does not qualify for investment grade rating by the three credit agencies. There is a chance the company will not be able to meet interest payments, may not have the money to redeem the bonds when they mature, or there is a possibility the company may declare bankruptcy and go out of business. Companies offer a higher return to compensate investors for the chance of default. Investors need to weigh
the return and their risk tolerance level before purchasing high-yield securities.
One way to invest in high-yield corporate bonds and reduce risk is to purchase a high-yield bond fund or ETF, exchange-traded fund. The funds hold a large number of bonds. If a bond defaults, the loss is nominal compared to the loss an investor would experience if the bond was held in the individual's portfolio. Most investors cannot purchase the large number of bonds comprising bond mutual funds. Spreading the risk across a large number of bonds produces sizable returns with reduced risk. Financial websites such as MSN Money, Yahoo Finance and Kiplinger contain tables of the highest ranking high yield corporate bond funds for one year and longer time periods. There is an interest rate risk with bond funds; therefore, when interest rates increase the value of the bond fund decreases. Investors may want to purchase short- and intermediate-term funds.
Individual high-yield corporate bonds can be purchased in investment portfolios. Investors need to carefully research the bonds before investing. Factors to consider are recent company financial history, bond payment history, coupon rate and schedule, credit agency ratings, market price and yield. The Bloomberg corporate bond page provides detailed data about current average bond rates. Fidelity Investments has a free interactive bond search screen. Investors should purchase individual bonds only if they can purchase a number of bonds.