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Fixed Income Securities (Bonds): Corporate Bonds

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What is a Corporate Bond?

A corporate bond is a debt instrument that is issued by a corporation and sold to investors. The company receives capital on the sale; the investor is paid a pre-established number of interest payments over time, at either a fixed or variable interest rate. These interest payments are taxable. When the bond reaches maturity, a fixed date stated upon issue, the payments cease and the original investment is returned to the buyer. Unlike corporate stock, corporate bonds do not give the buyer ownership in the company. However, a bond buyers becomes a creditor of the company.

The backing for the bond is generally the ability of the company to repay (the full faith and credit of the company), which depends on its prospects for future revenues and profitability. Most bonds are debentures, which means they do not offer collateral (usually, the company's physical property) for buyers if the company is unable to pay the bondholders. However, if a company files for bankruptcy, bondholders are paid what they are owed before stock holders. Corporations generally issue bonds as a form of debt financing, to support new business endeavors.

Bond Types

There are three types of corporate bonds:

Fixed Rate - fixed-rate bonds have an interest rate that does not change for the duration of the bond.

Variable - variable-rate bonds have an interest rate that varies, or "floats," during the duration of the bond. The rate is adjusted by a pre-determined formula, which is published in the bond's initial prospectus.

Zero Coupon - zero coupon bonds do not have an interest rate, but are offered for sale at below face value, before returning the face value on maturity. The interest is the difference between the offering price, or trade price, and the face value upon maturity.

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