Corporate Bonds

The whole unit on one sheet: bond mechanics, bond types, ratings, taxes, money-market instruments, and the yield ladder.

What Are the Bond Basics?

• Par (face) value is $1,000; coupon is the stated annual rate; interest pays semiannually.
• Quotation is a percentage of par: 98.50 = $985.00, 102 = $1,020.00.
• The bond indenture (trust indenture) is the legal contract; a trustee enforces it for bondholders.
• Callable bonds let the issuer redeem early (calling when rates fall to refinance) and pay higher coupons for call risk.

What Are the Types of Corporate Bonds?

• Secured (higher bankruptcy priority): mortgage bonds (real property), equipment trust certificates (safest corporate bonds), collateral trust bonds (pledged securities).
• Unsecured (debentures): backed only by general credit, the most common corporate bond. Subordinated debentures rank below senior debentures and secured debt.
• Liquidation priority: secured, senior unsecured, subordinated, preferred, common.
• Income (adjustment) bonds: pay interest only if the issuer earns enough; skipping is not default; trade flat.
• Zero-coupon: deep discount to par, no coupons, max interest-rate risk, no reinvestment risk, annual phantom income.
• High-yield (junk): below investment grade; higher coupon for greater default risk.

How Do Convertible Bonds Work?

• Convert into a fixed number of common shares at the bondholder's option; pays a lower coupon since the conversion feature has value.
• Conversion ratio = Par Value / Conversion Price (fixed at issuance; adjusts only for splits or stock dividends).
• Parity price of stock = Bond Market Price / Conversion Ratio. Parity price of bond = Stock Market Price x Conversion Ratio.
• Investment value (straight-bond value) is a price floor.

Which One-Liners Win Points?

• Bond ratings measure default (credit) risk only, never interest rate, market, liquidity, or reinvestment risk.

Which Numbers Matter Most?

How Are Corporate Bonds Rated?

• The "Big Three": Standard & Poor's (S&P), Moody's, and Fitch.
• Modifiers: S&P and Fitch use +/-; Moody's uses 1/2/3.
• Higher rating = lower yield; a downgrade drops price and lifts yield, an upgrade the reverse.
• Fallen angel: an investment-grade bond downgraded to junk; investment-grade-only institutions must sell, deepening the price drop.

How Is Taxable Debt Taxed?

• Coupon interest is ordinary income at the federal, state, and local level.
• OID = Par Value - Original Issue Price, accreted annually as ordinary income (phantom income); basis rises to par, so no gain or loss at maturity.
• Premium (bought above par) may be amortized to lower cost basis; optional on corporate bonds.
• Market discount (bought below par in the secondary market) is ordinary income at sale or maturity, not capital gain.

What Are the Money-Market and Structured Products?

• Commercial paper: short-term unsecured note, sold at a discount, registration-exempt at 270 days or less.
• Brokered CDs: FDIC insured; trade in the secondary market; may be callable; face rate risk if sold early.
• Eurodollar bonds: dollar-denominated, issued outside the U.S., pay interest annually, not registered.
• Exchange-traded notes (ETNs): unsecured issuer debt, no underlying portfolio, zero tracking error.

What Are the Bond Yield Types?

• Coupon (nominal) yield = Annual Coupon / Par Value (fixed).
• Current yield = Annual Coupon / Current Market Price (income only).
• Yield to maturity (YTM): total return if held to maturity; most comprehensive for non-callable bonds.
• Yield to call (YTC): total return to the first call date; use for callable premium bonds.
• Yield to worst: the lowest of YTM and all YTCs; equals YTC for premium callable, YTM for discount callable.

What Is the Memory Aid for Discount Climbs, Premium Dips?

Read the ladder by the comparison signs, not just by the left-to-right order:

• Discount bond: yields climb as you move right: Nominal < Current < YTM < YTC
• Premium bond: yields dip as you move right: Nominal > Current > YTM > YTC
• Par bond: yields stay flat: Nominal = Current = YTM

Which Gotchas Trip Students Up?

• Interest rate risk and reinvestment risk move in opposite directions.
• Phantom income on zeros and OID bonds is taxed annually with no cash received, so zeros fit tax-deferred accounts.
• FDIC on a brokered CD covers bank default only; selling early can still lose money to rate changes.
• Yankee bonds are SEC-registered and sold in the U.S.; Eurodollar bonds are not registered and sold outside the U.S.
• ETNs carry issuer credit risk; ETFs do not, because ETFs hold actual securities.

One-Breath Recap

Every corporate bond starts at $1,000 par, pays semiannual interest, and is quoted as a percentage of par, with secured debt outranking debentures in bankruptcy and investment grade stopping at BBB-/Baa3. Convertibles trade off a lower coupon for the holder's option to swap into stock, taxes turn on discount versus premium, and the yield ladder climbs on discount bonds and dips on premium bonds. Lock the numbers and the yield order and this unit answers itself.

Need more than the recap? Read the full Corporate Bonds unit.