Corporate Bond
Also known as: Credit, IG / HY bonds
Lending to companies for a spread: the extra yield is the price of the chance they don't pay you back.
1 · SnapshotThe one idea to remember
2 · BeginnerWhat is it, really?
A corporate bond is a loan to a company. Like a government bond it pays coupons and returns principal — but a company can genuinely go bust, so it must offer extra yield over government bonds. That extra is the credit spread, and it is the heart of the product.
The market splits into two worlds by rating: investment grade (BBB− and above — stable firms, modest spreads) and high yield or "junk" (BB+ and below — riskier firms, fat spreads and equity-like behaviour in downturns).
If default happens, bondholders don't lose everything: they queue up in bankruptcy and typically recover some fraction of face value — historically ~40% on average for senior unsecured bonds, more for secured, less for subordinated.
Point at a line to read what it is doing.
How do I read this chart?
Yield runs across, price up. The line falls, which is the whole of the relationship between the two — and it is curved rather than straight, which is convexity and the reason a bond gains more when yields fall than it loses when they rise by the same amount.
Where this is explained properly:
The axes carry no scale on purpose. Every line here is a stylised shape drawn to show a mechanism, so there is no number to read off one — and any figure taken from it would be invented.
- Asset class
- Fixed income (credit)
- Instrument type
- Corporate coupon bond
- Traded
- OTC dealer market
- Typical users
- Insurers, pension funds, credit funds
Which risks decide the outcome
Not how risky this is, and not a rating — there is deliberately no total. It says which of five failure modes drives what happens here, in the same order on all 129 products so they can be compared. This publication's own reading; see the notice below.
- Marketdecides it
- Creditdecides it
- Liquiditymatters
- Fundingbarely applies
- Operationalbarely applies
What decides it here. Two risks at once: the level of rates and the issuer's solvency. The asset swap and the default swap exist precisely to separate them.
3 · IntermediateHow it works in practice
Spread measures
- G-spread: yield minus the interpolated government yield.
- Z-spread: the constant spread over the swap/discount curve equating price to cash flows — the standard analytic.
- OAS: Z-spread after stripping embedded options (most corporates are callable).
What drives spreads
Expected default losses explain only part of spreads (the "credit spread puzzle"); the rest is compensation for illiquidity, downgrade risk, and the fact that defaults cluster in bad times exactly when losses hurt most. Spreads breathe with the economy: widening in recessions, grinding tighter in calm ones.
Structure matters
- Seniority: secured → senior unsecured → subordinated; each tier has its own spread and recovery.
- Covenants: promises limiting the issuer (debt caps, asset sales). High-yield bonds carry heavy covenant packages; their erosion ("cov-lite") is a cycle indicator.
- Calls: HY bonds are usually callable after a few years — investors price to the worst call date.
4 · AdvancedPricing & valuation
Reduced-form pricing
With hazard rate (default intensity) \(\lambda_t\) and recovery \(R\), the survival-weighted PV of a credit-risky bond:
What the symbols mean
- Pa price, or a present value
- ta point in time
- Cthe price of a call option
- Fthe forward or futures price
- rthe interest rate, per year
- lambdaan intensity, usually of defaults per year
The credit triangle \(s \approx \lambda(1-R)\) is the workhorse approximation linking spread, default intensity and loss severity. Calibrate \(\lambda\) from bond prices or CDS; differences between the two define the CDS-bond basis.
Structural view
Merton: equity is a call on firm assets, debt is a risk-free bond minus a put on those assets:
What the symbols mean
- Dduration: how far a bond's cash flows sit in the future
- Fthe forward or futures price
- rthe interest rate, per year
- Tmaturity, in years
- Pa price, or a present value
- Sthe price of the underlying today
This explains why spreads widen as equity falls and vol rises, and underpins quantitative default models (distance-to-default à la KMV).
Risk metrics
Credit portfolios are managed on spread duration (price sensitivity to spread moves, \(\Delta P/P \approx -D_s\,\Delta s\)) and DTS (duration times spread) — recognising that spread volatility is proportional to spread level. Jump-to-default risk is measured separately: JTD ≈ position × (1 − R).
New-issue mechanics
Primary markets price at a spread concession to secondaries; the concession, order-book coverage and post-break performance are the market's live health indicators.
The formulas above are standard textbook formulations, simplified for teaching. They explain the mechanism — they are not a valuation tool, and they will not reproduce a dealer’s price.
5 · Desk notesHow practitioners think about it
Now say it back
Close the page and give Corporate Bond in four sentences. It takes a minute and it is the only way to find out whether reading it was enough.
- Who wants what — two parties wanted opposite things badly enough to write it down.
- What the contract obliges, and when — not the payoff; the obligation.
- Where the money comes from — name the source, or you have described a hope.
- What makes it lose — the ordinary way, not the dramatic one.
Put Corporate Bond beside any other instrument →
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