Essay Example on Comparing Corporate Bonds to Government Bonds: Risks & Rewards

The corporate bond as the chosen publicly traded asset is a secured debt that is given by the corporation and then sold to the investors. The bond backing usually depends on the ability of the company to pay. The money spent is typically the one to be earned from the operations of the future (Timmer, Yannick 106). Comparing the corporate bond with the other surety, especially the government bond, the corporate bond is taken to be having higher risks. As a result, corporate bond always has a higher rate of interest; even for the top-flight credit companies. The corporate bonds are instruments of debt, exchanging the duty of the company to satisfy the claim to the capital and interest repayments (Timmer, Yannick 138).

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Each bond always has the essential three characteristics, which include; the value of the par or importance to be redeemed, the rate of interest or coupon, and lastly, the maturity period. Many corporate bonds are always not secured. In such a situation, the holder, just like any other creditors, possesses a claim over the general pool of assets of the company. But some bonds are secured depending on some assets which are specific of the credit enhancement benefits. The holders of the bond may be having some other protections regarding the particular agreement, which was entered into by the issuer as the result of explicitly being positioned ahead of other creditors or bondholders (Timmer, Yannick 140). The most important feature of the current years has been the growth in the secured bond on the domestic mortgages as well as the income streams of the future like the credit receivable.

The corporate bond issuers usually pay an interest rate, which is fixed, but a good number of the minority bonds provide a floating rate that is adjusted in line with the interest rate reference. Usually, interests are paid at the intervals which are fixed and can either be annual, semi-annually, quarterly or monthly based upon the maturity. Some companies offer the zero interest or coupon bonds whereby the investors get no interest during the bond life but subscribe for the bonds instead at some discount to the value of the bond's par. Bonds have the maturity which is original for one year at least. Usually, which are below the original maturity of 5 years, are generally issued as the Medium Term Notes programs (MTNs) (Houweling, Patrick, and Van Zundert 111).On the other hand, timelines may vary up to, but exceed 30 years seldom.

The corporations usually sell bonds because they are in debt financing form. The relationships can be the fundamental capital source for some enterprises, along with bank loans, equity, and the lines of credit. By speaking generally, the company may want to attain some earnings, which are consistent potential to be in a position to provide debt securities at the favorable coupon rate to the public (Israel et al.138). If the perceived quality of the company's credit is higher, it then becomes very more comfortable to provide more debts at the low prices. In a situation whereby the corporations need the short term boost of the capital, they may decide to sell a commercial paper that is the same as the bond but substantially matures in less or 270 days.

There is a relationship that is inverse between the bond yield and its value or price. If the returns required are of a high rate, the bond price reduced, and vice versa. However, such a relationship is usually not linear but is convex to the origin (Timmer, Yannick 145)

The Graph of Bond price against yield

The Return or yield Required

There are some pros and cons of the corporate bond that need to be considered before investing.

The pros if the corporate bond.The holders of the bond rank higher generally as the creditor than the shareholder - For some reason, if the company fails after the investment on the corporate bond has been made. Then the holders of the bond are typically rank higher than the shareholders are ranked when debts are being settled (Israel et al. 128). Thus the more top priority gives one an excellent opportunity to recover most of the Investments if not all even when the company goes below.

The payment of the bond coupon is structured - The amount of ticket are structured just like any other loan that a consumer may take away to buy something. Payment of other disbursements and dividend are at the company's discretion. Meaning that there are many certainties that investors have concerning getting the return on investment.

Corporate bond pricing is stable typically - One cannot have similar fluctuations in prices with the corporate bond the same way as shares or other opportunities invested in (Wang, Junbo, and Chunchi 200). It indicates that one can detect with some certainty the picture that the bond will possess and have the predictability on the income stream throughout the investment life.

Typically corporate bonds have a better return compared to other obligations - The corporate bonds are associated with fewer risks when compared to the different bond types such as the government bonds. Thus it indicates that there are high chances of greater returns. Purchasing a bond for a company which is reputable can sell the bonds potentially on a secondary market for a profit even if the rates of interest fall.

Some corporate bonds can be converted into stock - even though it is adding to the assumed risk by the investor, it means that the investment can as well be sold at the present market value. Thus, more profits can be brought under the right circumstances.

Cons of the corporate bond.The corporate bond may not diversify an individual's portfolio - Purchasing a corporate bond from the same company in which you are also a shareholder, then there is no diversification created in one's wallet. It is because, in any case, the company closed or collapse for some reason, one is left with huge losses and a little recovery chance.

The corporate bond does not provide capital growth - The growth of the capital is a type of investment that is not designed to improve in the value over the corporate bond's life. The timely payment of interest is received, assuming that the company gets the initial investment and does not default on them at the date of maturity.

It is tricky to sell the corporate bond - If an individual decides to get out of the corporate bond before the maturity date, then selling it again on the secondary market becomes very difficult (Wang, Junbo, and Chunchi 186). After investments, the rate of interest may go up, and more loss of getting cashback can be huge.

There are fewer buyers in the secondary markets - As the investment in a secondary market, it might be difficult to get buyers interested in the corporate bond. Thus, making it tricky on the investor who may want to have some cash immediately.The corporate bond becomes less profitable if the rate of interest increases - The corporate bond value is hampered with by the company stability, which in the first place is backing the bond. The profitability of the individual level investments may be affected by the situation. Therefore, the pros and cons of the corporate bond need to be appropriately considered before the investments are made.

Corporate bond bear market

Assuming that the next five to ten years brings in the season of the market returns of the low negative bond, most of the investors will want to get means of protecting their portfolio from the downturn impact. Having that in mind, below is some guidance showing what may or may not do well if the corporate bond enters a bear market (Chen et al. 110).

Avoiding the long - term bonds and focusing on the short maturities - the relationships which are short term are not exciting and do not provide much in the yield. Thus, they are very conservative investments that are not likely to experience more losses in the bear market (Houweling, Patrick, and Van Zundert 108). On the other hand, there is more interest risk in the long term bonds compared to short term bonds, and it indicates that the increasing rate of interest can crush the results of their performance.

Trying to avoid the Assets which are of high risk - Since not all bond segments react similar to the same stimuli set, to survive in the bear market, one needs to avoid high-risk assets.

Target corporate bond.The corporate bond target has a date of maturation of 15th April 2029, offering a 3.3750 percent coupon. The coupon payment is intended to occur 2,0 times per the biannual. The price currently of 108.78USD gives a yield of 2.35 percent (Wang, Junbo, and Chunchi 185).

The corporate bond size of the market (Houweling et al. 105)

Works Cited

Chen, Nan-Kuang, Shiu-Sheng Chen, and Yu-Hsi Chou. "Further evidence on bear market predictability: The role of the external finance premium." International Review of Economics & Finance 50 (2017): 106-121. DOI.org/10.1016/j.iref.2017.03.019

Houweling, Patrick, and Jeroen Van Zundert. "Factor investing in the corporate bond market." Financial Analysts Journal 73.2 (2017): 100-115. DOI/abs/10.2469/faj.v73.n2.1

Israel, Ronen, Diogo Palhares, and Scott A. Richardson. "Common factors in corporate bond returns." forthcoming in the Journal of Investment Management (2017).Timmer, Yannick. "Emerging market corporate bond yields and monetary policy." Emerging Markets Review 36 (2018): 130-143. DOI.org/10.1016/j.ememar.2018.04.001

Wang, Junbo, and Chunchi Wu. "Liquidity, credit quality, and the relation between volatility and trading activity: Evidence from the corporate bond market." Journal of Banking & Finance 50 (2015): 183-203. DOI.org/10.1016/j.jbankfin.2014.10.003