When a company issues debt capital, the name corporate bond is more fitting. This bond type may be secured or unsecured. The level of collateral attached to this debenture affects the risk. Which in turn affects the interest rate attached to the bond. In this article, let’s define corporate debenture and state some key points to note.
Definition — What is a Corporate Bond?
1. Corporate bond is a type of bond issued by a company to investors which promise to pay the principal at a fixed date which may be within 5 to 30 years.
2. It is a long-term source of finance from a well-reputed company to investors at a fixed interest rate that is higher than a Government Bond.
3. It can as well be defined as a form of debt capital issued to investors through a stock exchange market and it is used by companies to finance long-term projects.
A type of bond. Other types of bonds are government bonds, secured and unsecured, mortgage, state-own, convertible, mutual bonds, among others. A bond may have more than one feature. For example, a convertible bond may be secured or opened. While other bonds may be available for trading in a recognized stock exchange market.
Fixed date of payment. The bond usually carries a fixed date for payment. This is the day the principal amount is paid. For example, if a bond is 20 million US dollars at 14 percent per annum. And it’s repayable in 6 years. It means that by the end of the six years the principal amount, that is, 20 million will be paid. While the interest of 14 percent will be paid every year. In most cases, every three months.
Source of finance. A corporate bond is a source of funds to the company issuing it. There are majorly two sources of finance. Equity and debt financing. A company may decide to be financed by equity capital alone. Or be financed by both finance options. When an entity has a mixture of equity and debt, it is referred to as being levered or geared. We can say that company ABC is levered. Meaning it has debt capital as a source of finance.
Long-term source of finance. Aside from being a debt capital, it is also a long-term source of funds. Most corporate bonds may be as small as 5 years and up to 30 years. The recent corporate bond from MTN Nigeria is 7 years.
Fixed Income. Corporate Bond and other types of debentures are fixed-income investments. This means that their income is fixed. The stated interest attached to it remains the same over the lifetime of the bond. In the case of MTN bonds, the interest rate is fixed at 13 percent per annum.
Comparison between Corporate Bond and Government Bond
Both bonds can be traded on a recognized stock exchange market. This allows the investors to sell the bond if they don’t wish to hold it. It also gives other investors the chance to buy debentures, if they could not during the initial public offering.
The risk attached to both types is not the same. Government bonds are less risky. But the corporate bonds are very risky. Especially if it is unsecured. Most investments in the company’s debenture rely on the reputation and size of the corporation.
Interest rate. The interest rate for government debentures is low. This is because of the low risk attached to it. For corporate bonds, the risk is usually higher than the government’s and in many cases higher than the inflation rate of the country. This is to encourage investors to buy it. Also, the high risk attached to the company debentures makes the cost of capital to be higher.
Other Things to Note about Corporate Bond
Note that some corporate bond interest rates may be higher than others. If there is collateral or a group of collateral attached to the bond, the interest rate will be low. However, if the debenture relied on the company’s reputation (creditworthiness) of the corporation, the interest rate will be high.
When a company issues a risky corporate bond it is normal for them to register with a rating agency. Most Nigerian banks are registered with US rating agencies like Standard & Poor and Fitch rating. Their rating model gives the company either a boast or a warning to investors.
Issuing a corporate bond to the public and institutional investors usually pass through a lead and joint issuing house. For MTN Nigeria, the lead issuing house is Chapel Hill Denham Advisory. While six other issuing houses act as joint issuers.
In final words, a corporate bond is issued by reputable and well-known companies in a country. The debenture is made available to the public and institutional investors like pension fund administrators and insurance companies. Furthermore, a corporate bond pays more interest rate than a government bond.