Private sector bonds, frequently called corporate bonds, are bonds that companies issue to investors to raise funds for projects. Both public and private companies issue private sector bonds. For investors, private sector bonds vary widely in their characteristics, such as their credit ratings, maturities and yields.
Investing in private bonds means purchasing a bond from the issuing corporation. Bond prices often are in multiples of $1,000 or $5,000. Bonds are attached with a specified rate of interest that the issuer agrees to pay investors in return for their cash. Interest payments typically are paid to investors semiannually. In addition, bonds have maturity dates when the issuers must repay investors the face value of the bond, which usually is close to the price that the investor paid for the bond. In general, corporate bonds offer a lower possible ceiling on returns than stocks, but their focus on steady returns and higher yields than municipal bonds makes them attractive to many investors.
Private sector bonds enable the corporations that issue them to invest in projects that they view as important to their development. Construction projects are a common use of the funds raised from private sector bonds, such as building a new factory or office facility. Issuers also use funds raised through bonds to purchase new equipment necessary to their business goals. Other bond-fueled projects target a company's expansion in other ways. Corporations are more likely to issue bonds to raise money when interest rates are low, so that the debt costs them less. If you are considering purchasing private sector bonds, it can be helpful to understand the company behind the bond and their purpose for it.
The risk for investors in private sector bonds is that the company will default on the bond and not be able to make principal and interest payments to investors when they are due. This risk can be especially stark when economic conditions are troubled, and the possibility exists that companies will overextend themselves and will be unable to live up to their bond obligations when revenue expectations are not met. Private sector bonds carry a greater risk than government-backed securities and have a higher default rate. For instance, U.S. Treasury securities have federal government backing and have no perceived risk. Credit ratings for bonds serve to indicate the levels of risk that bonds carry, so you can use that measurement to gauge the risk of a particular bond issue.
Corporate bonds' relative riskiness, in relation to municipal bonds and U.S. treasury securities, mean that they offer higher yields in general than their counterparts. They also provide higher yields than municipal bonds because the income generated for investors in municipal bonds is tax-free, so corporate bonds must have higher yields to compete with them. Corporate bonds with lower credit ratings and greater risk to investors typically compensate with greater rewards, offering investors a higher rate of return on their investments in exchange for the risk they are taking.
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