Corporate Bonds

Corporate bonds are debt securities issued by corporations to raise capital. They offer higher yields than government securities but carry additional credit risk.

Corporate Bond Basics

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Secured vs. Unsecured Bonds

Secured Bonds (Backed by Collateral)

Advantage: If issuer defaults, bondholders can claim specific assets.

Unsecured Bonds (Debentures)

Debentures are backed only by the issuer's creditworthiness and general assets—no specific collateral.

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Seniority Hierarchy (Liquidation Order)

If a company goes bankrupt, claims are paid in this order:

Key Point: Bondholders are paid before stockholders in bankruptcy.

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Special Bond Features

Callable Bonds

When Called: Interest rates have fallen—issuer refinances at lower rate, investor loses high-coupon bond.

Putable Bonds

When Exercised: Interest rates have risen—investor "puts" bond back to get cash to reinvest at higher rates.

Convertible Bonds

Example:

• Bond converts to 40 shares (conversion ratio)
• $1,000 par ÷ 40 shares = $25 conversion price
• If stock rises above $25, conversion becomes attractive

Zero-Coupon Bonds

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Credit Ratings

Credit ratings assess the probability of default:

Investment Grade: BBB-/Baa3 and above High Yield (Junk): BB+/Ba1 and below

Credit Spread

Credit spread = Corporate bond yield − Treasury yield of same maturity

Credit spreads typically widen during recessions and narrow during expansions.

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In Practice: How Investment Advisers Apply This

Portfolio construction:

• Use investment-grade corporates for income with moderate risk
• Consider high-yield for aggressive income strategies
• Convertibles for equity-like upside with bond-like downside
• Match credit quality to client risk tolerance

Risk considerations:

• Callable bonds have reinvestment risk
• Subordinated debt has higher loss severity in default
• Credit spreads indicate market sentiment about default risk

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On the Exam

The Series 65 exam tests your understanding of:

1. Secured vs. unsecured: Mortgage bonds, debentures
2. Seniority: Secured > Senior unsecured > Subordinated > Equity
3. Callable bonds: Benefit issuer; reinvestment risk for investor
4. Convertible bonds: Exchange for stock; lower coupon
5. Credit ratings: Investment grade (BBB-/Baa3 and above) vs. junk

Expect 2-3 questions on corporate bonds. Common formats include identifying bond types and understanding callable/convertible features.

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Key Takeaways

• Secured bonds are backed by specific collateral; debentures are unsecured
• Seniority: Secured > Senior > Subordinated > Preferred > Common
• Callable bonds benefit the issuer (can refinance at lower rates)
• Putable bonds benefit the investor (can sell back if rates rise)
• Convertible bonds have lower yields but stock upside potential
• Investment grade: BBB-/Baa3 and above; Junk: BB+/Ba1 and below
• Credit spreads widen when risk increases; narrow when confidence returns
• All corporate bond interest is fully taxable