Corporate bonds are issued by private corporations, and the proceeds are used to finance the corporations’ growth. Large corporations may have multiple bond issues outstanding. Corporate bonds are typically relatively long-term securities, and they may be traded on exchanges or over the counter. Corporate bonds are usually issued with a par value of $1,000, and the interest is taxable.
Many companies prefer to use bonds instead of, or in addition to, selling equity. Bonds offer some significant advantages over equity as a capital-raising method: bonds are often cheaper to issue than equity, they are available to companies that are too small to go public, they pose fewer regulatory headaches, and they do not dilute the ownership of existing shareholders.
Corporate bonds may be either secured or unsecured. A bond (or any other kind of debt) is said to be secured if the creditor has legal rights with respect to some of the debtor’s property, which the creditor may invoke if the debtor defaults. This might include a right to literally take the property, or to receive some or all of the property’s value if it is liquidated in bankruptcy. The creditor is said to have a security interest in the property. Secured corporate bonds are less risky than unsecured ones, all other things being equal.
An unsecured corporate bond is also known as a debenture. Debentures are backed only by the good faith of the issuer. Because debentures are riskier than secured bonds, they generally pay a higher coupon than secured bonds. As a general rule, the higher the risk a company poses to creditors, the higher the coupon it must offer on its debentures. Junk bonds pay the highest interest rate (if the company doesn’t default first).
