When corporations and governments need money to finance projects and growth, they can turn to the public to borrow money. Bonds are borrowing contracts. Investors buy them at one rate and are promised a specific amount of return on their principle. In some cases, bonds also come with coupons for collecting interest payments at predetermined intervals. Bond holders are not investors who take ownership in a company, but creditors with first rights to assets if a company or government defaults on its debt. Because companies can fail and go bankrupt, corporate bonds are often considered riskier, but potentially more profitable, than those issued by the U.S. Treasury.
The most attractive aspect of a corporate bond is the yield. Because few corporations have the credibility of the U.S. government, their bonds are considered riskier. After all, corporations can have unexpected changes in their business model, environment and management that can impact their sustainability, whereas the U.S. government continues to operate through good times and bad. To compensate for the added risk, corporations offer higher rates of return on their bonds – often well exceeding that of Treasury bonds and interest rates.
Some corporate bonds reward investors with interest payments. In exchange for parting with their money for an extended period of time, companies make periodic, pre-agreed interest payments. The combination of interest and gains from maturity of a bond can lead to a much better performance than Treasury bonds, which don't typically offer interest payments.
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Corporate bonds come in many varieties and levels of risk and return. Some traditional, well-capitalized, longstanding blue chip companies offer bonds with AA ratings – almost as high as Treasury bonds. Others have much lower ratings, but can present fantastic returns to an investor willing to take the risk. Those looking for diversified bond portfolios can find significantly more options among corporate bonds.
For those who want to sell a bond before it reaches maturity, Treasury bonds can seem very attractive. After all, their high safety rating makes them a safe bet that many other investors are willing to take. However, strong liquid markets exist for corporate bonds too. Even better for investors, corporate bond prices fluctuate more than Treasury securities. Therefore, a smart investor can carefully monitor the market and sell at a point when she can get a decent return on investment, still reaping some profit, even without a bond reaching maturity.