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What are corporate bonds?
What are corporate bonds?
25 January 2023#Private Banking

What are corporate bonds?

The bond market includes corporate bonds.
Let's find out together what they are!

Corporate bonds are bond instruments issued by private companies (European and non-European), traded on a regulated market. The bond holder becomes a creditor of the issuing company and is entitled to receive repayment of the coupon amount at maturity.

Unlike government bonds, these instruments are mainly subject to the credit risk of the issuer. It is precisely for this reason that corporate bonds are divided into different types according to their degree of riskiness, measured by their rating: specifically, we identify Investment Grade and High Yield issues. The rating is in fact a decisive factor in establishing the yield required by the market during the initial placement of the security (primary market) but also in subsequent price quotations (secondary market); the lower the rating, the higher the spread that the issuing company must offer to convince investors to subscribe to it. In the course of the security's life, a change in rating may occur, which implies a change in market prices. This is because the two factors are directly related: the greater the rating change, the greater the price fluctuation will be.

In general, these financial instruments are aimed at qualified investors, who are better equipped to assess the implied credit risk, and have a high minimum denomination, above EUR 100,000. Only in specific cases can corporate bonds be purchased by retail/non-qualified investors; sometimes the bond may have been created ad hoc for this purpose, thus presenting well-defined characteristics such as minimum investment required, prospectus and distribution channel used.

The issuers

The issuers are typically companies with a larger capitalisation, well-known to investors, and belonging to sectors such as energy, automotive, TMT and utilities. Their bonds normally have a 'benchmark' size of at least EUR 500 million. The issuers of these financial instruments also tend to return to the capital market periodically, which is why they are considered 'frequent issuers', using bonds as a stable source of financing.

Investment Grade Bonds

Investment grade is an indicator of the credit quality of a financial instrument, usually a bond. Investment Grade Bonds are defined as issues with a rating (judgement) higher than BBB- on the rating scale used by Standard & Poors or Baa2 on Moody's scale. They are usually issued by large companies with stable businesses and strong balance sheets precisely because they represent a relatively safe and low-risk investment.

High Yield Bonds

High Yield (HY) bonds, on the other hand, are corporate bonds with a rating below BBB- and typically between BB+ and CC: they are characterised by higher risk, precisely because the risk of non-payment of interest and principal at maturity to subscribers is higher. A BB security will tend to be more volatile than an AA security, demonstrating the greater impact of credit risk on market prices for lower-rated securities. HY issuers include fallen angels, large companies that were rated Investment Grade but have been downgraded to BB over time due to a deterioration of their market and/or financial situation. For bonds rated BB- and below, the credit risk increases further: investors who choose this type of issue assume a higher risk of default as well as higher price volatility during the life of these securities. Of course, the opposite scenario can occur in which a high-yield bond is upgraded to Investment Grade (rising stars): this will immediately trigger a downward repricing of the spread, causing the bond price to rise.