By BRIAN HEPP is a financial consultant and (310) 453-0077 or at
MANY OF THE WORLD’S LARGEST COMPANIES ARE based in America, yet they have operations that span the globe and collectively earn enormous amounts of money from a wide range of commercial activities. Interestingly though, despite their own profit-making ventures, large corporations still seek out investors to help finance some of their activities. Two ways in which they do this are by issuing stock, which represents ownership in the company, or by selling bonds, which puts you — the individual investor — in the position of making a loan to a big company.
When a company issues bonds, these “loans” help with the company’s long-term financing for capital expenditures and acquisitions. Investors who buy bonds enter an agreement with the company stating it will pay back the face value of the bond at maturity (a pre-determined date in the future) plus a fixed rate of interest.
This interest rate is known as the nominal, or coupon rate, and payments are often made every six months throughout the life of the bond. Its face value, also called the “par” value, is typically listed in multiples of $1,000.
In contrast to a stockholder, who actually gains ownership in a company by purchasing stock, bondholders are creditors of the issuing corporation. An investment in a bond literally represents a loan to the company.
While stockholders typically look for the price of their shares to go up, bondholders receive interest payments on the money they have loaned out. Even though there are other ways to profit from stocks and bonds,“owning” versus “loaning” is the basic difference between the two types of investments.
Corporate bonds can be a valuable component in a well-rounded investment portfolio. Some of the many benefits they offer include the following: Regular income — If you buy a bond and hold onto it until maturity, you will have a pretty good idea of how much you will get back from your investment because of the regular interest payments you will receive.
Reliability — Credit-rating agencies rate corporate bonds based on several factors relating to the issuing company. When issuing bonds, a company that has a good credit history and makes principal and interest payments to bondholders on a timely basis will typically receive a good credit rating. Bonds with strong ratings historically have had minimal credit risk.
Diversification — Companies from a wide range of industrial sectors and geographic locations offer corporate bonds, giving investors a good opportunity to diversify their investments by holding a variety of different securities.
These bonds also represent various credit ratings and have different maturity rates, which refers to the date your “loan” comes due. To give you an idea of their scope, financial services firms, transportation companies and even public utilities are just a few of the many types of businesses that issue bonds.
As with many investment vehicles, there are certain risks associated with investing in bonds. Interest rate risk refers to the possibility that a bond’s market value will change in response to interest rate changes. A bond’s price moves in the opposite direction of interest rates.
As rates rise, the price drops. Again, if you hold a bond until maturity, you won’t have to even worry about interest rate risk. But it’s a consideration should you ever think about selling your bond early.
Bonds also entail credit risk — the risk credit rating agencies attempt to gauge when they issue ratings on bond issues. But despite the risks involved, many investors typically view bonds as a balancing addition to their portfolio.
And aside from just its simple investment value, a bond represents your chance to lend a hand to the progress of some of our great American companies.
Originally published in the Santa Monica Daily Press print edition on December 5, 2007. Read the original PDF.