Corporate Bonds

The range of corporate bonds issued each year allows investors to tailor a bond portfolio around their specific needs. The various types of corporate bonds offer different risk levels, as well as varying yields and payment schedules.

Fixed-rate coupons
The most common form of corporate bond is one that has a stated coupon that remains fixed throughout the bond's life. It represents the annual interest rate, usually paid in two installments every six months, although some bonds pay annually, quarterly, or monthly. The payment amount is calculated as a percentage of the par value, regardless of the purchase price or current market value. With corporate bonds, one bond represents $1,000 par value, so a 5% fixed-rate coupon will pay $50 per bond annually ($1,000 × 5%). The payment cycle is not necessarily aligned to the calendar year; it begins on the "Dated Date," which is either on or soon after the bond's issue date, and ends on the bond's maturity date, when the final coupon and return of principal payment are paid.

Investment grade vs. non-investment grade (high yield)
Corporate bonds are generally rated by one or more of the three primary ratings agencies: Standard & Poor's, Moody's, and Fitch. These firms base their ratings on the bond issuer's financial health and likely ability to make interest payments and return the bondholders' principal. Rated bonds fall into one of two categories: investment grade or non-investment grade (also known as high yield). Investment grade bonds are considered to be lower risk and, therefore, generally pay lower interest rates than non-investment grade bonds, though some are more highly rated than others within the category. Non-investment grade bonds are considered to be higher risk or speculative investments. The higher yield reflects an increased risk of default. A company's financial health can change, and when it does, its bonds' ratings may change as well. So an investment grade bond could become non-investment grade over time and vice versa.

Zero-coupon
Zero-coupon corporate bonds are issued at a discount from face value (par), with the full value, including imputed interest, paid at maturity. Interest is taxable, even though no actual payments are made. Prices of zero-coupon bonds tend to be more volatile than bonds that make regular interest payments.

Callable and puttable
The issuer of a callable corporate bond maintains the right to redeem the security on a set date prior to maturity and pay back the bond's owner either par (full) value or a percentage of par value. The call schedule lists the precise call dates of when an issuer may choose to pay back the bonds and the price at which they will do so. The callable price is generally expressed as a percent of par value, but other all-price quotation methods exist.

With a puttable security, or put option, the investor has the right to put the security back to the issuer, again at a set date or a trigger event prior to maturity. A common example is the "survivor's option," whereby if the owner of the bond dies, the heirs have the ability to put back the bond to the issuer and typically receive par value in return.

Step-up 
Interest on step-up securities is paid at a fixed rate until the call date, at which time the coupon increases if the bond is not called.

Step-down
Interest on step-down securities is paid at a fixed rate until the call date, at which time the coupon decreases if the bond is not called.

Floating-rate
The coupon on a floating-rate corporate bond changes in relationship to a predetermined benchmark, such as the spread above the yield on a six-month Treasury or the price of a commodity. This reset can occur multiple times per year. The coupon and benchmark can also have an inverse relationship.

Variable- and adjustable-rate
Variable- and adjustable-rate corporate bonds are similar to floating-rate bonds, except that coupons are tied to a long-term interest rate benchmark and are typically only reset annually.

Convertible bonds*
Convertible bonds can be exchanged for a specified amount of the common stock of the issuing company, although provisions generally restrict when a conversion can take place. While these bonds offer the potential for appreciation of the underlying security, prices may be susceptible to stock market fluctuations.

Choice
The range of corporate bonds issued each year allows investors to tailor a bond portfolio around specific needs. Investors should, however, consider that each issuer has its own unique risk profile.

Secondary market
An active secondary market exists for many corporate bonds, which creates liquidity for investors. Investors need to remember that some issues can be thinly traded, which may impact pricing and may pose a challenge when selling.

New issues
Customers are able to access new issue corporate bonds through the CorporateNotes Program^SM. Each week a limited number of new issue corporate bonds are available for purchase at par, in minimum denominations of $1,000, without additional mark-up.

Ratings
Most corporate bonds are rated by at least one of the major rating agencies. Fidelity offers both investment grade and non-investment grade bonds, which are classified according to their rating. When considering an investment in corporate bonds, remember that higher potential returns are typically associated with greater risk.

Yields
Corporate bonds are among the highest yielding fixed income securities. In fact, the yield differential over Treasuries may be great enough to outpace inflation over the long term. Because interest is fully taxable, buyers should evaluate their tax situations before investing.

When investing in corporate bonds, investors should remember that multiple risk factors can impact short- and long-term returns. Understanding these risks is an important first step towards managing them.

Credit and default risk
Corporate bonds are subject to credit risk. It’s important to pay attention to changes in the credit quality of the issuer, as less creditworthy issuers may be more likely to default on interest payments or principal repayment. If a bond issuer fails to make either a coupon or principal payment when they are due, or fails to meet some other provision of the bond indenture, it is said to be in default. One way to manage this risk is to diversify across different issuers and industry sectors.

Market risk
Price volatility of corporate bonds increases with the length of the maturity and decreases as the size of the coupon increases. Changes in credit rating can also affect prices. If one of the major rating services lowers its credit rating for a particular issue, the price of that security usually declines.

Event risk
A bond’s payments are dependent on the issuer’s ability to generate cash flow. Unforeseen events could impact their ability to meet those commitments.

Call risk
Many corporate bonds may have call provisions, which means they can be redeemed or paid off at the issuer’s discretion prior to maturity. Typically an issuer will call a bond when interest rates fall, potentially leaving investors with a capital loss or loss in income and less favorable reinvestment options. Prior to purchasing a corporate bond, determine whether call provisions exist.

Make-whole calls
Some bonds give the issuer the right to call a bond, but stipulate that redemptions occur at par plus a premium. This feature is referred to as a make-whole call. The amount of the premium is determined by the yield of a comparable mature Treasury security, plus additional basis points. Because the cost to the issuer can often be significant, make-whole calls are rarely invoked.

Step-up coupon 
If your Corporate Note has a step-up coupon schedule, the interest rate of your Corporate Note may be higher or lower than prevailing market rates. Generally, a step-up Corporate Note pays a below-market interest rate for an initial defined period (often one year). After the expiration of that initial period, the coupon rate generally increases, and the Corporate Note will pay this interest rate until the next step, at which time it changes again, and so on through the maturity date. Holders bear the risk that the step-up coupon rate might be below future prevailing market interest rates. Because step-up Corporate Notes typically include call provisions, holders also bear the risks associated with callable bonds. In this regard, it is important to understand that if your Corporate Note is called, you will not benefit from the interest payment(s) of the later step(s). The initial rate on a step-up Corporate Note is not the yield to maturity. You receive the yield to maturity (YTM) only if you hold the Corporate Note until maturity (i.e. it is not sold or called). Please review the step-up schedule and call information found in the coupon and attribute columns of the search results page or in the Statutory Prospectus.

Sector risk
Corporate bond issuers fall into four main sectors: industrial, financial, utilities, and transportation. Bonds in these economic sectors can be affected by a range of factors, including corporate events, consumer demand, changes in the economic cycle, changes in regulation, interest rate and commodity volatility, changes in overseas economic conditions, and currency fluctuations. Understanding the degree to which each sector can be influenced by these factors is the first step toward building a diversified bond portfolio.

Interest rate risk
If interest rates rise, the price of existing bonds usually declines. That’s because new bonds are likely to be issued with higher yields as interest rates increase, making the old or outstanding bonds less attractive. If interest rates decline, however, bond prices usually increase, which means an investor can sometimes sell a bond for more than face value, since other investors are willing to pay a premium for a bond with a higher interest payment. The longer a bond’s maturity, the greater the impact a change in interest rates can have on its price. If you’re holding a bond until maturity, interest rate risk is not a concern.

Inflation risk
Like all bonds, corporate bonds are subject to inflation risk. Inflation may diminish the purchasing power of a bond’s interest and principal.

Foreign risk
In addition to the risks mentioned above, there are additional considerations for bonds issued by foreign governments and corporations. These bonds can experience greater volatility, due to increased political, regulatory, market, or economic risks. These risks are usually more pronounced in emerging markets, which may be subject to greater social, economic, regulatory, and political uncertainties.