Corporations issue bonds to fund new business ventures, expand operations, and purchase equipment. When a corporation issues bonds, it is borrowing a specified amount of money (or “principal”) from investors and promising to return the principal on a specified date (the “maturity date”). Until the maturity date, the corporation also pays investors a stated rate of interest. Unlike many municipal bonds, the interest payments received by investors from corporate bonds are taxable. Corporate bonds are typically issued in multiples of $1,000 or $5,000 and fall into two broad categories: investment-grade and speculative-grade.
Suppose a corporation is interested in building a new factory for $5 million and decides to issue bonds to pay for the construction. The corporation may choose to sell 5,000 bonds to investors (or “bondholder”) for $1,000 each. In this case, the “face value” of each bond is $1,000. The corporation (or “issuer”) determines an annual interest rate (or “coupon”) and a timeframe (“term”) within which it will repay the principal ($5 million). To determine the coupon, the issuer takes into account prevailing interest rates to ensure that the coupon is attractive to investors and competitive with comparable bonds in the marketplace. This hypothetical corporation may decide to sell 5-year bonds with an annual coupon of 5%. At the end of 5 years, the bond reaches maturity and the corporation repays the $1,000 face value to each bondholder.