Investor BulletIn

What Are Corporate Bonds? 

The SEC’s Office of Investor Education and Advocacy is 

issuing this Investor Bulletin to offer basic information 

about corporate bonds. 

What is a corporate bond?

A bond is a debt obligation, like an Iou. Investors who 

buy corporate bonds are lending money to the company 

issuing the bond. In return, the company makes a legal 

commitment to pay interest on the principal and, in 

most cases, to return the principal when the bond comes 

due, or matures. 

to understand bonds, it is helpful to compare them with 

stocks. When you buy a share of common stock, you own

equity in the company and will receive any dividends 

declared and paid by the company. When you buy a 

corporate bond, you do not own equity in the company. 

You will receive only the interest and principal on the 

bond, no matter how profitable the company becomes or 

how high its stock price climbs. But if the company runs 

into financial difficulties, it still has a legal obligation to 

make timely payments of interest and principal. the 

company has no similar obligation to pay dividends to 

shareholders. In a bankruptcy, bond investors have priority 

over shareholders in claims on the company’s assets. 

like all investments, bonds carry risks. one key risk to a 

bondholder is that the company may fail to make timely 

payments of interest or principal. If that happens, the 

company will default on its bonds. this “default risk” 

makes the creditworthiness of the company—that is, its 

ability to pay its debt obligations on time—an important

concern to bondholders. 

What are the basic types of corporate 

bonds?

Corporate bonds make up one of the largest components 

of the u.s. bond market, which is considered the largest 

securities market in the world. other components include

u.s. treasury bonds, other u.s. government bonds, and 

municipal bonds.

Companies use the proceeds from bond sales for a wide 

variety of purposes, including buying new equipment, 

investing in research and development, buying back their 

own stock, paying shareholder dividends, refinancing 

debt, and financing mergers and acquisitions.

Bonds can be classified according to their maturity, which

is the date when the company has to pay back the 

principal to investors. Maturities can be short term (less 

than three years), medium term (four to 10 years), or long

term (more than 10 years). longer-term bonds usually 

offer higher interest rates, but may entail additional risks. 

Bonds and the companies that issue them are also 

classified according to their credit quality. Credit rating 

agencies assign credit ratings based on their evaluation 

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of the risk that the company may default on its bonds. 

Credit rating agencies periodically review their bond ratings

and may revise them if conditions or expectations change.

Based on their credit ratings, bonds can be either 

investment grade or non-investment grade. Investmentgrade bonds are considered more likely than non-investment grade bonds to be paid on time. non-investment 

grade bonds, which are also called high-yield or speculative bonds, generally offer higher interest rates to compensate investors for greater risk.

Bonds also differ according to the type of interest payments they offer. Many bonds pay a fixed rate of interest 

throughout their term. Interest payments are called 

coupon payments, and the interest rate is called the coupon 

rate. With a fixed coupon rate, the coupon payments stay 

the same regardless of changes in market interest rates.

other bonds offer floating rates that are reset periodically, 

such as every six months. these bonds adjust their 

interest payments to changes in market interest rates. 

Floating rates are based on a bond index or other benchmark. For example, the floating rate may equal the 

interest rate on a certain type of treasury bond plus 1%. 

one type of bond makes no interest payments until the 

bond matures. these are called zero-coupon bonds, because 

they make no coupon payments. Instead, the bond 

makes a single payment at maturity that is higher than 

the initial purchase price. For example, an investor may 

pay $800 to purchase a five-year, zero-coupon bond with 

a face value of $1,000. the company pays no interest on 

the bond for the next five years, and then, at maturity, 

pays $1,000—equal to the purchase price of $800 plus 

interest, or original issue discount, of $200. Investors in 

zero-coupon bonds generally must pay taxes each year 

on a prorated share of the interest before the interest is 

actually paid at maturity. 

What happens if a company goes 

into bankruptcy?

If a company defaults on its bonds and goes bankrupt, 

bondholders will have a claim on the company’s assets 

and cash flows. the bond’s terms determine the bondholder’s place in line, or the priority of the claim. Priority 

will be based on whether the bond is, for example, a 

secured bond, a senior unsecured bond or a junior 

unsecured (or subordinated) bond. 

In the case of a secured bond, the company pledges specific 

collateral—such as property, equipment, or other assets 

that the company owns—as security for the bond. If the 

company defaults, holders of secured bonds will have a 

legal right to foreclose on the collateral to satisfy their claims. 

Bonds that have no collateral pledged to them are 

unsecured and may be called debentures. Debentures 

have a general claim on the company’s assets and cash 

flows. they may be classified as either senior or junior 

(subordinated) debentures. If the company defaults, 

holders of senior debentures will have a higher priority 

claim on the company’s assets and cash flows than 

holders of junior debentures.

Bondholders, however, are usually not the company’s only 

creditors. the company may also owe money to banks, 

suppliers, customers, pensioners, and others, some of 

whom may have equal or higher claims than certain bondholders. sorting through the competing claims of creditors 

is a complex process that unfolds in bankruptcy court. 

What are the financial terms of a bond? 

the basic financial terms of a corporate bond include its 

price, face value (also called par value), maturity, coupon 

rate, and yield to maturity. Yield to maturity is a widely 

used measure to compare bonds. This is the annual 

return on the bond if held to maturity taking into 

account when you bought the bond and what you 

paid for it.

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A bond often trades at a premium or discount to its face 

value. this can happen when market interest rates rise or 

fall relative to the bond’s coupon rate. If the coupon rate 

is higher than market interest rates, for example, then the 

bond will likely trade at a premium. 

Financial Term Bond A Bond B Bond C

Price (as a % of face value) 100 90 110

Maturity 10 years 10 years 10 years

Face value $1,000 $1,000 $1,000 

Coupon rate 4.00% 4.00% 4.00%

Yield to maturity 4.00% 5.31% 2.84%

Bond A. Bond prices may be quoted in dollars or as a 

percentage of its face value. Bond A’s price is 100% of 

the face value, or $1,000. the bond will pay 4% of the 

face value, or $40 per year. Most bonds are paid semiannually, so Bond A will pay $20 every six months. In 

addition, the bond will make a principal payment of 

$1,000 at the end of the 10 years. the bond pays a 4.00%

yield to maturity because it is not trading at either a 

premium or a discount. 

Bond B. Bond B’s price is 90% of its face value, or 

$900. notwithstanding this, investors in Bond B will still 

receive a total of $40 per year in coupon payments and 

when Bond B matures, bondholders will still receive the 

face value of $1,000. the discounted price results in 

Bond B having a yield to maturity of 5.31%.

Bond C. this bond sells for a premium at $1,100, or 

110% of face value. like Bonds A and B, investors in 

Bond C will receive a total of $40 per year in coupon 

payments and the bond’s face value of $1,000 at maturity.

Because of the premium price, the yield to maturity on 

Bond C at 2.84% is lower than the coupon rate.

What’s the relationship among bond 

prices, interest rates and yield?

the price of a bond moves in the opposite direction than 

market interest rates—like opposing ends of a seesaw. 

When interest rates go up, the price of the bond goes 

down. And when interest rates go down, the bond’s price 

goes up. As shown above, a bond’s yield also moves 

inversely with the bond’s price.

For example, let’s say a bond offers 3% interest, and a 

year later market interest rates fall to 2%. the bond will 

still pay 3% interest, making it more valuable than newly 

issued bonds paying just 2% interest. If you sell the 3% 

bond, you will probably find that its price is higher than 

a year ago. Along with the rise in price, however, the yield

to maturity for any new buyer of the bond will go down. 

now suppose market interest rates rise from 3% to 4%. 

If you sell the 3% bond, it will be competing with new 

bonds that offer 4% interest. the price of the 3% bond 

may be more likely to fall. the yield to maturity for any 

new buyer, however, will rise as the price falls.

It’s important to keep in mind that despite swings in 

trading price with a bond investment, if you hold the 

bond until maturity, the bond will continue to pay the 

stated rate of interest as well as its face value upon 

maturity, subject to default risk. 

What are some of the risks 

of corporate bonds?

Credit or default risk

Credit or default risk is the risk that a company will fail 

to timely make interest or principal payments and thus 

default on its bonds. Credit ratings try to estimate the 

relative credit risk of a bond based on the company’s 

ability to pay. Credit rating agencies periodically review 

their bond ratings and may revise them if conditions or 

expectations change.

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the corporate bond contract (called an indenture) often 

includes terms called covenants designed to limit credit 

risk. For instance, the terms may limit the amount of 

debt the company can take on, or may require it to 

maintain certain financial ratios. violating the terms 

of a bond may constitute a default. the bond trustee 

monitors the company’s compliance with the terms of its 

indenture. the trustee acts on behalf of the bondholders 

and pursues remedies if the bond covenants 

are violated. 

Interest rate risk

As discussed above, the price of a bond will fall if market 

interest rates rise. this presents investors with interest rate

risk, which is common to all bonds, even u.s. treasury 

bonds. A bond’s maturity and coupon rate generally 

affect its sensitivity to changes in market interest rates.

the longer the bond’s maturity, the more time there is 

for rates to change and, as a result, affect the price of the 

bond. therefore, bonds with longer maturities generally 

present greater interest rate risk than bonds of similar 

credit quality that have shorter maturities. to compensate investors for this interest rate risk, long-term bonds 

generally offer higher interest rates than short-term 

bonds of the same credit quality.

If two bonds offer different coupon rates while all of 

their other characteristics are the same, the bond with the 

lower coupon rate will generally be more sensitive to 

changes in market interest rates. For example, imagine 

one bond that has a coupon rate of 2% while another 

bond has a coupon rate of 4%. All other features of the 

two bonds—when they mature, their level of credit risk, 

and so on—are the same. If market interest rates rise, then

the price of the bond with the 2% coupon rate will fall 

by a greater percentage than that of the bond with the 

4% coupon rate. This makes it particularly important 

for investors to consider interest rate risk when they 

purchase bonds in a low-interest rate environment. 

Inflation risk

Inflation is a general rise in the prices of goods and 

services, which causes a decline in purchasing power. 

With inflation over time, the amount of money received 

on the bond’s interest and principal payments will purchase

fewer goods and services than before. 

Liquidity risk

liquidity is the ability to sell an asset, such as a bond, 

for cash when the owner chooses. Bonds that are traded 

frequently and at high volumes may have stronger 

liquidity than bonds that trade less frequently. liquidity 

risk is the risk that investors seeking to sell their bonds 

may not receive a price that reflects the true value of the 

bonds (based on the bond’s interest rate and creditworthiness of the company). If you own a bond that is 

not traded on an exchange, you may have to go to a 

broker when you want to sell it. In addition, the bond 

market does not have the same pricing transparency as 

the equity market, as the dissemination of pricing 

information is more limited for corporate bonds in 

comparison to equity securities such as common stock.

Call risk

the terms of some bonds give the company the right to 

buy back the bond before the maturity date. this is 

known as calling the bond, and it represents “call risk” to 

bondholders. For example, a bond with a maturity of 10 

years may have terms allowing the company to call the 

bond any time after the first five years. If it calls the bond, 

the company will pay back the principal (and possibly an

additional premium depending on when the call occurs). 

one reason the company may call the bond back is if 

market interest rates have fallen relative to the coupon 

rate on the bond. that same decline in market interest 

rates would likely make the bond more valuable to bondholders. thus, what is financially advantageous to the 

company is likely to be financially disadvantageous to 

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the bondholder. Bondholders may be unable to reinvest 

at a comparable interest rate for the same level of risk. 

Investors should check the terms of the bond for any 

call provisions or other terms allowing for prepayment. 

How can investors reduce their risks?

Investors can reduce their risks by diversifying their assets. 

Bonds are one type of asset, along with shares of stock 

(or equity), cash, and other investments. 

Investors also can diversify the types of bonds they hold. 

For example, investors could buy bonds of different 

maturities—balancing short-term, intermediate, and longterm bonds—or diversify the mix of their bond holdings 

by combining corporate, treasury, or municipal bonds. 

Investors with a greater risk tolerance may decide to buy 

bonds of lower credit quality, accepting higher risks in 

pursuit of higher yields. More conservative investors, 

however, may prefer to limit their bond holdings solely 

to high-quality bonds, avoiding riskier or more speculative

bonds. 

Instead of holding bonds directly, investors can invest in 

mutual funds or exchange-traded funds (etFs) with a 

focus on bonds. Investors should base their decisions on 

their individual circumstances.

How do I research my bond or 

bond fund investment?

A prospectus is the offering document filed with the 

seC by a company that issues bonds for sale to the 

public in a registered transaction. Among other things, 

the prospectus relating to a corporate bond issuance 

describes the terms of the bond, significant risks of 

investing in the offering, the financial condition of the 

company issuing the bond, and how the company plans 

to use the proceeds from the bond sale. similarly, if you 

are investing in a bond-focused mutual fund or etF, 

these funds also prepare prospectuses detailing important 

information about the fund. Investors can ask their 

broker-dealer for the prospectus of any bond or bond 

fund in which they are interested. Prospectuses also are 

available to the public without charge on the seC’s 

eDGAr website, available at www.sec.gov/edgar/

searchedgar/webusers.htm. You can also find a bond 

fund’s prospectus at the bond fund’s website.

Regular periodic reports are filed by both companies that have sold bonds in a public offering and by 

bond-focused mutual funds and etFs. Companies that 

have sold bonds in a public offering file quarterly reports

on Form 10-Q and annual reports on Form 10-K, 

among other filings. You can use these reports to learn 

about and monitor a company’s financial condition. 

Mutual funds and etFs file annual and semiannual 

reports that detail the performance and holdings of the 

fund. these reports are available to the public without 

charge on the seC’s eDGAr website. You can also 

often find the reports of a bond fund at the bond fund’s 

website.

Reports on price and trading histories for 

particular bonds are available to the public without 

charge at FInrA’s Market Data Center at www.finra.org/

Investors/MarketData/P124134.

Broker-dealer background checks can help 

investors avoid fraud. You can check the background 

of broker-dealers on FInrA’s BrokerCheck website at

www.finra.org/brokercheck.

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Additional Information

For our Investor Bulletin on high-yield bonds, visit 

sec.gov/investor/alerts/ib_high-yield.pdf.

For more information on mutual funds generally, 

visit sec.gov/investor/pubs/beginmutual.htm. 

For our Investor Bulletin on etFs, visit sec.gov/

investor/alerts/etfs.pdf. 

For “using eDGAr - researching Public Companies,” visit www.investor.gov/researching-managinginvestments/researching-investments/using-edgarresearching-public-companies.

For our Investor Bulletin on reading a Form 10-K, 

visit sec.gov/investor/pubs/reada10k.pdf.

For our Investor Bulletin on reading fund reports, 

visit sec.gov/investor/alerts/ib_readmfreport.pdf. 

For more on bonds in general, visit FInrA’s 

smart Bond Investing at www.finra.org/Investors/

InvestmentChoices/Bonds/smartBondInvesting/

Introduction/.

For more information about credit rating agencies, 

visit our Fast Answer at sec.gov/answers/nrsro.htm

and the website for the seC’s office of Credit 

ratings at sec.gov/about/offices/ocr.shtml. 

For more information about municipal bonds, see 

our Investor Bulletin on municipal bonds at sec.

gov/investor/alerts/municipalbondsbulletin.pdf, and 

visit the Municipal securities rulemaking Board’s 

electronic Municipal Market Access (eMMA)

website at www.emma.msrb.org.

For more educational information, visit the seC’s 

website for individual investors at www.investor.gov.

The Office of Investor Education and Advocacy has provided this information as a service to investors. 

It is neither a legal interpretation nor a statement of SEC policy. If you have questions concerning the 

meaning or application of a particular law or rule, please consult with an attorney who specializes in 

securities law.

SEC Pub. No. 149 (6/13)