Risks of investing in corporate bonds

Question 1. Although corporate bonds have lower total annual returns per year than common stocks, corporate bonds are not risk free. For example, Enron's filing for bankruptcy in December 2001 was one of the largest bankruptcy filings in the U.S. The creditors received less than twenty cents on the dollar for their investments. Similarly, when WorldCom declared bankruptcy, its creditors received less than forty cents on the dollar for their investments. Bond investors who were just seeking income from their bond investments experienced significant principal losses.

What are some of the risks of investing in corporate bonds? Despite these risks, why do investors still invest in corporate bonds?

Question 2. Corporations can finance themselves through many ways such as common stock, corporate debt, and preferred stock. The cost of common stock can be determined using the capital asset pricing model (CAPM). Not all common stocks pay a common stock cash dividend; however, it is quite common for a bond to pay interest. This bond interest payment is a major reason bond investors buy coupon-paying corporate bonds. The preferred stock financing option, however, is used less frequently by corporations compared to corporate debt and common stock financing options.

How does a corporate bond compare with preferred stock? How does the valuation of a corporate bond compare with the valuation of preferred stock?

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Finance Basics: Risks of investing in corporate bonds
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