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Consequently, this default risk can be quantified using spread analysis, which seeks to determine the difference in yield between a given corporate bond and a risk-free [[treasury bond]] of the same maturity. Common statistics used include [[Z-spread]] and [[option-adjusted spread]] (OAS). The [[new issue concession]] is used when valuing soon to be issued corporate bonds as it is the new bond's yield minus the yield of an existing bond from the same issuer for about the same maturity date. |
Consequently, this default risk can be quantified using spread analysis, which seeks to determine the difference in yield between a given corporate bond and a risk-free [[treasury bond]] of the same maturity. Common statistics used include [[Z-spread]] and [[option-adjusted spread]] (OAS). The [[new issue concession]] is used when valuing soon to be issued corporate bonds as it is the new bond's yield minus the yield of an existing bond from the same issuer for about the same maturity date. |
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== Other risks in Corporate Bonds == |
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Default Risk has been discussed above but there are also other risks for which corporate bondholders expect to be compensated by credit spread. This is, for example why the Option Adjusted Spread on a Ginnie Mae MBS will usually be higher than zero to the Treasury curve. |
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Credit Spread Risk. The risk that the credit spread of a bond (extra yield to compensate investors for taking default risk), which is inherent in the fixed coupon, becomes insufficient compensation for default risk that has later deteriorated. As the coupon is fixed the only way the credit spread can readjust to new circumstances is by the market price of the bond falling and the yield rising to such a level that an appropriate credit spread is offered. |
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Interest Rate Risk. The level of Yields generally in a bond market, as expressed by Government Bond Yields, may change and thus bring about changes in the market value of Fixed-Coupon bonds so that their Yield to Maturity adjusts to newly appropriate levels. |
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Liquidity Risk. There may not be a continuous secondary market for a bond, thus leaving an investor with difficulty in selling at, or even near to, a fair price. |
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Supply Risk. Heavy issuance of new bonds similar to the one held may depress their prices. |
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Inflation Risk. Inflation reduces the real value of future fixed cash flows. An anticipation of inflation, or higher inflation, may depress prices immediately. |
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Tax Change Risk. Unanticipated changes in taxation may adversely impact the value of a bond to investors and consequently its immediate market value. |
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== Corporate bond indices == |
== Corporate bond indices == |
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Revision as of 17:31, 9 March 2010
A corporate bond is a bond issued by a corporation. It is a bond that a corporation issues to raise money in order to expand its business. [1]The term is usually applied to longer-term debt instruments, generally with a maturity date falling at least a year after their issue date. (The term "commercial paper" is sometimes used for instruments with a shorter maturity.)
Sometimes, the term "corporate bonds" is used to include all bonds except those issued by governments in their own currencies. Strictly speaking, however, it only applies to those issued by corporations. The bonds of local authorities and supranational organizations do not fit in either category.[clarification needed]
Corporate bonds are often listed on major exchanges (bonds there are called "listed" bonds) and ECNs like MarketAxess, and the coupon (i.e. interest payment) is usually taxable. Sometimes this coupon can be zero with a high redemption value. However, despite being listed on exchanges, the vast majority of trading volume in corporate bonds in most developed markets takes place in decentralized, dealer-based, over-the-counter markets.
Some corporate bonds have an embedded call option that allows the issuer to redeem the debt before its maturity date. Other bonds, known as convertible bonds, allow investors to convert the bond into equity.
One can obtain an unfunded synthetic exposure to corporate bonds via credit default swaps.
Types
Corporate debt falls into several broad categories:
Generally, the higher one's position in the company's capital structure, the stronger one's claims to the company's assets in the event of a default.
Risk analysis
Compared to government bonds, corporate bonds generally have a higher risk of default. This risk depends, of course, upon the particular corporation issuing the bond, the current market conditions and governments to which the bond issuer is being compared and the rating of the company. Corporate bond holders are compensated for this risk by receiving a higher yield than government bonds.
Consequently, this default risk can be quantified using spread analysis, which seeks to determine the difference in yield between a given corporate bond and a risk-free treasury bond of the same maturity. Common statistics used include Z-spread and option-adjusted spread (OAS). The new issue concession is used when valuing soon to be issued corporate bonds as it is the new bond's yield minus the yield of an existing bond from the same issuer for about the same maturity date.
Other risks in Corporate Bonds
Default Risk has been discussed above but there are also other risks for which corporate bondholders expect to be compensated by credit spread. This is, for example why the Option Adjusted Spread on a Ginnie Mae MBS will usually be higher than zero to the Treasury curve.
Credit Spread Risk. The risk that the credit spread of a bond (extra yield to compensate investors for taking default risk), which is inherent in the fixed coupon, becomes insufficient compensation for default risk that has later deteriorated. As the coupon is fixed the only way the credit spread can readjust to new circumstances is by the market price of the bond falling and the yield rising to such a level that an appropriate credit spread is offered.
Interest Rate Risk. The level of Yields generally in a bond market, as expressed by Government Bond Yields, may change and thus bring about changes in the market value of Fixed-Coupon bonds so that their Yield to Maturity adjusts to newly appropriate levels.
Liquidity Risk. There may not be a continuous secondary market for a bond, thus leaving an investor with difficulty in selling at, or even near to, a fair price.
Supply Risk. Heavy issuance of new bonds similar to the one held may depress their prices.
Inflation Risk. Inflation reduces the real value of future fixed cash flows. An anticipation of inflation, or higher inflation, may depress prices immediately.
Tax Change Risk. Unanticipated changes in taxation may adversely impact the value of a bond to investors and consequently its immediate market value.
Corporate bond indices
Corporate bond indices include the Barclays Corporate Bond Index, the Citigroup US Broad Investment Grade Credit Index, and the Dow Jones Corporate Bond Index.
References
- ^ Sullivan, arthur (2003). Economics: Principles in action. Upper Saddle River, New Jersey 07458: Pearson Prentice Hall. p. 281. ISBN 0-13-063085-3.
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