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Corporate Bond Prices

If there's one thing we all know about corporate bond prices, it's that they fluctuate. They fluctuate so much that it can be good for investors to understand why.

There are three main things that drive changes in a corporate bond's yield and, as a result, its price. Firstly, there's its closeness to its redemption date. The closer a bond is to the date at which it will be redeemed for its nominal value by the issuing company; the likelier it is to be priced close to or at that value. Otherwise, there is a quick capital gain or loss to be made by holding.

The interest rate environment is another important factor. As interest rates rise and fall, the risk-free rate available from longer-term government bonds rises and falls too. This has an impact on corporate bond yields since a government bond at a particular yield will always be more attractive than a corporate bond offering the same yield.

Thirdly, there is the risk of the bond defaulting. If you were offered a 4% yield from a government bond with a minimal risk of default, you wouldn't accept a $% yield from a much riskier corporate bond. Investors demand a higher return for the risks of holding a corporate bond. This reduces the corporate bond's price.

This is what is called a credit risk. If investors believe that there is a higher chance of a bond defaulting than is reflected in the current market price, they will demand a higher return for holding it. This higher yield creates a lower price.

This is the biggest distinction between government and corporate bonds. Corporate bonds can, and sometimes do, default.

The difference between the risk free rate and the yield on a corporate bond is called the yield spread. What investors demand in terms of yield is influenced by the economy and the market. In the current market, fear has led to a wide spread between government bonds and even highly-rated corporate bonds. In contrast, when the market is booming, spreads usually narrow as investors chase yield and boost the prices of assets.

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