Corporate Bond

A corporate bond is defined by three sets of terms. The cash-flow terms fix the coupon rate and frequency (semi-annual for most US issues, annual for many European ones), the maturity date and the redemption structure, which may be a single bullet payment, a sinking fund, or an embedded call or put. The legal terms sit in the indenture: the promise to pay, the covenants, and the trustee's authority to act for holders on a default.

The ranking terms determine recovery. Secured debt is tied to specific collateral; senior unsecured ranks on the general claim against the firm; subordinated and junior tranches sit behind it. Within a group, holders are treated pari passu. Structural subordination matters just as much as contractual ranking: debt issued by a holding company is repaid only from cash upstreamed by operating subsidiaries, after those subsidiaries' own creditors are satisfied.

The yield to maturity is simply the single discount rate that equates the bond's promised coupons and principal to its market price, so quoting a price and quoting a yield are the same statement. The analytically useful part is the difference between that yield and a risk-free reference: the G-spread against an interpolated government yield, the I-spread against a swap rate, and for callable or putable issues the option-adjusted spread, which strips out the value of the embedded option so that bonds with different structures can be compared.

That spread compensates for more than expected default loss. It also pays for liquidity, for the uncertainty around recovery rates, for downgrade and spread-volatility risk, and for taxes in some jurisdictions. Since spread change drives price, the relevant sensitivity is credit spread duration: the approximate percentage price move is minus spread duration times the change in spread, which is why long-dated low-coupon credit reprices most violently in a risk-off episode.

Issuance is intermediated. Large firms sell registered public deals through underwriting syndicates, use medium-term note programmes for smaller opportunistic drawdowns, or place bonds privately with institutions, including Rule 144A deals in the United States that reach qualified buyers without full registration. Pricing is set as a spread over a benchmark on the day, guided by the issuer's ratings, its existing curve and comparable deals.

Secondary trading is overwhelmingly dealer-based and over the counter rather than exchange-listed, with quotes in spread or price and settlement conventions differing across markets. Liquidity is concentrated in recently issued benchmark-size bonds; older, smaller issues can go days without a trade, which is why matrix pricing is used to value them. Index funds and credit ETFs have become an important marginal source of demand and, in stressed markets, the visible price signal for a market whose underlying bonds trade thinly.

Be able to move between price, coupon and yield for a plain bullet bond at any point in its life, including accrued interest and the distinction between clean and dirty price. Be able to state how a call feature caps price appreciation and why the appropriate comparison for such a bond is the option-adjusted spread rather than the nominal spread.

Be able to rank claimants correctly in a hypothetical bankruptcy, explain why the absolute priority of claims is often departed from in negotiated reorganisations, and distinguish a rating on the issuer from a rating on a specific issue, which reflects seniority and collateral. Finally, be able to explain the drivers of spread change over a cycle: deteriorating fundamentals widen spreads, but so does a withdrawal of dealer balance-sheet capacity, and the two can be hard to separate in real time.