What are corporate bonds? An explanation for beginners on the differences from stocks, whether they can be bought via NISA, and the risks involved
When researching stock investments, you may come across the term “corporate bond.”
How are they different from stocks?
If you receive interest, are they safe?
In the first place, why do companies raise money from individuals instead of banks?
I was curious, so I looked into how corporate bonds work.
Based on the information I found, I will organize it here so that even investment beginners can understand.
1. What exactly is a corporate bond?
A corporate bond is a bond issued by a company to raise money.
Companies sometimes need money for capital investment or business expansion.
One way to raise those funds is by issuing corporate bonds.
People who purchase corporate bonds are in the position of lending money to the company.
With typical corporate bonds, interest is paid according to predetermined conditions, and the face value is repaid at maturity.
However, this assumes that the company can pay as promised.
Depending on the company’s financial situation, there is a possibility that interest or principal may not be paid.
2. Why do companies raise money from individuals instead of borrowing from banks?
This is the part I was particularly curious about.
Borrowing from a bank is not the only way for a company to raise money.
By issuing corporate bonds, they can raise funds from individuals and institutional investors.
So, why do they choose the corporate bond method?
Reason 1: It increases the ways to raise money
Methods for a company to raise funds include bank loans, issuing corporate bonds, and issuing stocks.
If a company can raise money from investors rather than relying solely on banks, its options for fundraising expand.
Reason 2: Depending on the conditions, it can be more advantageous than bank borrowing
When a company borrows money, it incurs costs such as interest.
With corporate bonds, conditions such as the interest rate and maturity date are set at the time of issuance.
Depending on the company’s creditworthiness and market conditions, it may be possible to raise funds under more favorable terms than borrowing from a bank.
However, issuing corporate bonds also involves costs for procedures and management.
It is not necessarily always cheaper than bank borrowing.
Reason 3: It may be possible to raise the necessary funds in a lump sum
Companies that need large amounts of money for major capital investments may issue corporate bonds to raise funds from multiple investors.
However, issuing corporate bonds does not guarantee that the required amount will be raised.
The amount and terms that can be raised vary depending on the company’s creditworthiness and market environment.
In other words, a company does not necessarily issue corporate bonds because it cannot borrow money from a bank.
For a company, one of the goals is to increase the options for how it raises funds.
3. What is the difference between stocks and corporate bonds?
The major difference lies in your position when providing money to a company.
Stocks are an investment, while corporate bonds are a loan.
This difference also changes how you receive money.
In the case of stocks
When you purchase stocks, you become a shareholder of that company.
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If the stock price rises, you may be able to earn a capital gain.
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You may be able to receive dividends
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If the stock price falls, you may incur a loss when selling
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If the company goes bankrupt, you may lose the money you invested
Stock prices and dividends are not guaranteed in advance.
In the case of corporate bonds
When you purchase corporate bonds, you are in the position of lending money to a company.
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Receive interest according to the contract terms
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At maturity, you will in principle receive repayment of the face value
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If you sell before maturity, the price may be lower than the purchase price
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If the company falls into bankruptcy or similar, principal and interest may not be paid
Ordinary corporate bonds do not carry voting rights as a shareholder.
Although the mechanisms of stocks and corporate bonds differ, both are financial products that carry the possibility of loss.
4. Can corporate bonds be bought with NISA?
This is a point where mistakes are easily made.
Directly purchasing corporate bonds themselves is not eligible for NISA.
NISA covers stocks and investment trusts that meet certain conditions.
However, this does not mean that all investment trusts that include corporate bonds as investment targets are excluded.
Whether an investment trust that incorporates bonds such as corporate bonds is eligible for NISA depends on the specific product.
You need to think of ‘buying corporate bonds directly’ and ‘buying investment trusts that incorporate corporate bonds’ as separate things.
5. Are there conditions for buying corporate bonds?
Corporate bonds have purchase conditions for each issue.
When considering a purchase, check the following items.
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Minimum purchase amount: The minimum amount required to purchase
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Interest rate: The level of interest set
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Maturity: When the principal is scheduled to be repaid
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Interest payment schedule: When interest payments will be received
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Creditworthiness of the issuing company: The likelihood of being able to pay principal and interest
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Conditions for mid-term sale: Whether it can be sold before maturity
Some corporate bonds for individual investors have a minimum purchase unit set at around 1 million yen.
However, not all corporate bonds can be purchased starting from the same amount.
Actual conditions must be confirmed in the offering documents or prospectus for each specific issue.
6. How should corporate bonds be considered as an asset value?
Unlike stocks, corporate bonds are characterized by pre-determined conditions such as interest rates and maturity.
If the issuing company makes payments as promised, you will receive interest and the face value in accordance with the contract terms.
However, the value of a corporate bond is not always constant.
For example, if market interest rates rise after purchase, the market price of already issued corporate bonds generally tends to fall.
Also, if the creditworthiness of the issuing company declines, the price of the corporate bond may fall.
The results may differ between holding until maturity and selling mid-term.
In other words, while corporate bonds are products with fixed maturity and interest conditions, they are not products that can be converted into cash at the same amount at any time.
7. What are the risks of corporate bonds?
There are three main risks to check when understanding corporate bonds.
1. Credit risk
This is the risk that the issuing company may fall into bankruptcy or similar, making it unable to pay interest or principal.
Even if a company is well-known, payment is not necessarily guaranteed.
A company’s financial status and credit ratings can serve as references for judging creditworthiness.
However, even with a high credit rating, repayment of the principal is not guaranteed.
2. Price fluctuation risk
If you sell before maturity, the selling price will change depending on market interest rates and the company’s creditworthiness.
If the price has fallen since the time of purchase, you may incur a loss upon sale.
3. Liquidity risk
This is the risk that you may not be able to sell at your desired price when you want to sell.
Corporate bonds are different from stocks, which are traded daily on an exchange.
Depending on the issue or market conditions, it may become difficult to sell, or you may only be able to sell at a price lower than expected.
For foreign currency-denominated bonds, you must also consider foreign exchange risk in addition to these.
8. Things to check when researching corporate bonds
When comparing corporate bonds, it is important not to judge them solely by the interest rate.
Here is a summary of items you should check.
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Financial status of the issuing company
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Credit ratings and their meaning
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Interest rates and payment terms
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Period until maturity
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Minimum purchase amount
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Conditions for selling before maturity
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Possibility that principal or interest may not be paid
Corporate bonds with high interest rates may carry corresponding credit risks and the like.
You cannot simply judge them as a good deal because the interest rate is high, or safe because they are secure.
Summary
Here is a summary of what I learned about corporate bonds this time.
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What are corporate bonds: Bonds issued by companies to borrow money
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Reason for issuance by companies: To increase methods of fundraising and gather funds that meet their conditions
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Difference from stocks: Stocks are investments, while corporate bonds are loans
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NISA: Direct purchase of corporate bonds themselves is not eligible
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Purchase conditions: Minimum purchase amounts and maturities vary by issue
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Asset value: Market prices fluctuate, and selling midway may result in losses
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Main risks: Credit risk, price fluctuation risk, and liquidity risk
Corporate bonds are financial products with a different structure than stocks.
Having fixed interest and maturity conditions is not the same as being safe.
Understanding why companies issue corporate bonds and how they work is also useful for learning about financial products.
If you are considering a purchase, it is important to check not only the interest rate but also the creditworthiness of the issuing company, the maturity, and the conditions for selling midway.
*This article explains the basic structure of corporate bonds and does not recommend the purchase of any specific issue.
Official information referenced
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Japan Securities Dealers Association: “Features and risks of corporate bonds for individuals, and how to obtain price information”
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Japan Securities Dealers Association: “Corporate bonds for individuals”
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Financial Services Agency: “Learning about NISA”
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J-FLEC: “Features of financial products”
Since the terms of systems and products are subject to change, please check the latest official information when considering a purchase.