A corporate bond is issued by a corporation to raise funds for the expansion of its business. Corporate bonds involve long-term yields, which mature at least 12 months after their date of issuance. Corporate bonds are registered on exchanges, and tax is applied to the interest accrued on them. The main categories of corporate bonds are unsecured debt, secured debt, subordinated debt and senior debt. Corporate bonds involve higher risk than other types of bonds and therefore often pay higher yields.
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Convertible bonds are those that can easily be changed into the common stock of a corporation. The yield generated by them depends on the conversion price, conversion ratio, parity, conversion premium and the call price. The conversion price is the price per share at which the bond is converted to common stock. Conversion ratio is the number of common stock shares each bond converts to. The conversion value or parity is a product of the conversion ratio and the equity price. The conversion premium is the difference between the value of the convertible bond in the market and its parity value. Call features is the facility provided to the issuer of some bonds to call them early for recovery. This is dependent on the performance of the share prices.
There are many variants of convertible bonds, including exchangeables (XB), contingent convertibles (coco), vanilla convertible bonds and SPV (special purpose vehicles) structures.
Zero Coupon Bonds
Zero coupon bonds are issued at highly discounted rates. Interest payable on them is not a steady stream of income as is common with other types of bonds. Instead, the interest is compounded and paid in bulk when the bond reaches its maturity. Zero coupon bonds pay highly attractive yields and are typically held by investors till they mature. The bond yields its principal amount (or face value) in addition to all accumulated interest upon maturity.
A junk bond, also known as a speculative bond or a high-yield bond, offers higher than normal yields to investors but comes with a greater risk. Junk bonds are categorised as fallen angels or rising stars, depending on the investment grade. Bonds are given investment grades that range from AAA to BBB. A bond with an AAA grade has the lowest risk while BBB grade simply has higher risk. Low B grade bonds (BB or B) and C grade bonds qualify as junk and carry the highest risk.
A fallen angel is a bond that has been reduced to a junk bond due to the substandard quality rating of the issuing company. A rising star bond is one with an increasing grade due to the issuing company’s improved credit rating.
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