What is the Corporate Bond Market?

Gregory Hanson

The corporate bond market is a segment of the bond market that deals with debt obligations issued by corporate, rather than governmental, entities. Large bond trading exchanges do exist, but there is no single central market for corporate bonds, and many are bought and sold entirely outside of exchanges. Corporations turn to the corporate bond market to generate medium or long-term cash reserves and offer a variety of different bonds for sale to investors. These bonds differ in the rate and type of return, as well as the level of protection afforded to bondholders in the event that the issuing corporation enters bankruptcy proceedings.

Lower interest rates set by the Federal Reserve have contributed to the rise of the corporate bond market.
Lower interest rates set by the Federal Reserve have contributed to the rise of the corporate bond market.

The governments of the world, and particularly the government of the United States, issue the majority of all bonds in circulation. Corporations account for a smaller share of the world bond market, but the corporate bond market offers a greater rate of return to investors who are willing to accept a somewhat greater degree of risk. Corporate bonds are rated by several different rating agencies, including Moody’s and Standard and Poor’s. These ratings, on scales that are unique to the rating agencies, are designed to give investors an idea of the overall credit-worthiness of the corporation issuing the bond.

The debt of corporations considered good candidates to repay is termed ‘investment grade’, whereas the riskier bonds, issued by weaker corporations, are often referred to as ‘junk’ bonds. As with any investment, greater risk offers greater reward. Investors who are willing to take a risk on bonds with weak ratings can realize substantial returns but face the very real risk of default, which is generally a much smaller risk on bonds with better ratings.

Several different varieties of bonds are offered for sale on the corporate bond market. Some pay interest, while other bonds do not, but are sold for much less than their face value, so that interest is still priced in. Corporate bonds also differ in the degree of security that they offer investors in the event of bankruptcy. Many categories of bond exist, but as a general rule, bonds that place investors closer to the front of the line to claim corporate assets in the event of a bankruptcy are more secure but pay a lower interest rate.

Firms offer bonds for sale on the corporate bond market for several different reasons. In some cases, corporations require cash to meet existing obligations, and elect to turn to the corporate bond market to secure that cash. In other cases, corporations will seek cash not to meet existing obligations, but to place themselves in a strong financial position, or to take advantage of particularly low interest rates to build up a fund for use in subsequent corporate investments. The low interest rates offered by the Federal Reserve in an attempt to ameliorate the effects of the financial crisis that began in 2008 induced many corporations to build cash reserves in this fashion.

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