What Is a Corporate Bond?

Michael Whitman · Trading since 2017, full-time since 2020 · Reviewed 2026-09-14

A government bond has one main risk: rates. A corporate bond has two — rates, and whether the company is still there. Almost everything distinctive about them comes from that second one.

How it works

You lend to a company and it contracts to pay you back. Fixed coupons on a schedule, principal at maturity, and a legal obligation rather than a discretionary one.

If the company fails, order matters. Secured lenders and banks are paid first, then bondholders, then shareholders — who usually receive nothing. That ranking is the whole reason a bond is a lower-risk claim on the same business than its shares.

The credit spread is the extra yield over a government bond of the same maturity. A corporate paying 6.5% against a government paying 4% has a 250-basis-point spread.

That 250 is not free income. It is the market’s price for the chance the payments stop, and it is priced by people who do this professionally.

The spread moves on its own

Spreads widen in bad conditions and narrow in good ones, independently of what government rates are doing. So a corporate bond can fall while government bonds rise, which surprises anyone treating “bonds” as one asset.

And the effect is not uniform. High-quality issuers move a little; the weakest move enormously. That is precisely when a portfolio built for income discovers it was built for something else.

This is the correlation problem. Low-grade corporate bonds fall when equities fall, because both are responding to the same worry about the same companies. The diversification they appear to offer is weakest exactly when it is wanted.

A worked example

A government bond at 4% and a corporate at 6.5%, both ten years, both duration 8.

Rates rise one point. Both fall about 8% on duration alone.

Spreads also widen by one point, as they tend to when rates rise sharply. The corporate falls a further 8%, for about 16% total.

Same maturity, same duration, double the loss — and the second half came from a risk the duration figure never described. That is the practical meaning of having two exposures in one instrument.

Ratings

Agencies grade issuers from investment grade down to high yield, which is the polite name for junk. The line between the two matters more than any single notch, because many institutions are only permitted to hold investment grade.

A downgrade across that line forces selling by holders who have no choice, into a market where the buyers already know. That is a mechanical price effect with nothing to do with the company’s prospects on the day.

And a rating is an opinion. It is produced by an agency paid by the issuer, it lags events, and it has been wrong at scale before.

The original data

Use this site’s thirty-year fee measurement for scale: 5 basis points a year costs 1.5% of the final balance, 20 costs 5.8%, 75 costs 20.2%, 150 costs 36.5%.

A 250-basis-point credit spread dwarfs every figure in that table. Over thirty years it is the difference between two completely different outcomes — which is the honest way to see what the market thinks default risk is worth, rather than reading the spread as a bonus.

And corporate bonds are expensive to trade. A round trip on this site’s shared series costs 0.0098, about 2% of the median bar range — and corporate bond spreads are wider than that relative to what is being captured, because the market is dealer-based rather than exchange-traded.

The covenants

The contract usually restricts what the company may do while the debt is outstanding: limits on further borrowing, on asset sales, on dividends paid out to shareholders. Those are covenants, and they exist because your claim is only as good as the balance sheet behind it.

Covenant quality has weakened over time. “Covenant-lite” describes debt issued with few of these protections, and it has become common in the high-yield market — which means the nominal ranking above shareholders comes with less practical defence than it once did.

A breach usually triggers a renegotiation rather than an immediate default, and the terms of that renegotiation depend entirely on how much leverage the bondholders retained. Reading which covenants exist is the part of corporate bond analysis that has no equivalent in government debt.

When it fails

The characteristic failure is buying high-yield corporate bonds as the safe part of a portfolio. The word “bond” carries the assumption of stability, the yield is visibly better than government debt, and the holding is placed where the ballast is supposed to sit. Then a downturn arrives, the spread widens fastest in exactly the weakest names, and the position falls alongside the equities it was meant to offset. It behaved correctly; it was simply never the asset it was being used as.

A second failure is reading yield without reading the spread. The yield is rates plus credit, and only one of those is compensation for the company.

A third is trusting the rating as a measurement rather than an opinion produced by a paid agency.

A fourth is holding single names in small size. One default in a concentrated bond holding removes a chunk of capital that many coupons do not replace.

And a fifth is assuming recovery is zero or total. Defaults usually recover something, the amount varies enormously by seniority, and that recovery rate is part of what the spread is pricing.

Related

Bond market covers where these trade and why the costs are high. Spread covers the trading cost that shares the same name as the credit spread. And risk management covers sizing a holding with two exposures in it.

This page is educational, not financial advice. Test every idea on your own charts before risking money.