Corporate bond

A bond issued by a company to borrow money from investors, usually paying a higher interest rate than government bonds to reflect greater risk.

What it means

Companies issue bonds to fund operations, expansion or refinancing. Investors earn regular interest and get the face value back at maturity if the company stays solvent. Credit rating agencies grade issuers: investment-grade bonds come from financially stronger companies, while high-yield or junk bonds pay more because default is more likely.

Investors can lose money if the company defaults, if its credit rating falls, or if interest rates rise and the bond’s market price drops. Some bonds are callable, meaning the company can repay early, often when rates fall. Corporate bond interest is taxed as ordinary income at both the federal and state level, and gains or losses from selling are capital gains or losses.

Example

For example, a $10,000 investment in a corporate bond paying 5% earns $500 a year in interest, which is taxed as ordinary income in a taxable account.

How it’s used

Earning more income than government bonds offer
Diversifying a bond portfolio, often through a bond fund
Matching a fixed payment stream to future needs

Strengths and weaknesses

Strengths

Higher yields than comparable government bonds
Predictable income if held to maturity without default
Wide range of maturities and credit qualities

Weaknesses

Default and downgrade risk, highest for high-yield bonds
Interest fully taxable federally and by states
Prices fall when rates rise, and callable bonds may be repaid early

Educational information only, not financial, tax or legal advice. Rules, limits and rates change; check the IRS, your lender or plan, or a qualified professional before acting.