Corporate Bonds

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Corporate Bonds

Corporate bonds are debt securities that enterprises issue to raise capital for various needs. They are issued by private companies or public corporations. By purchasing a corporate bond, the buyer lends money to the issuing company. In return, the company promises to repay this loan, the ‘principal’, on a specific maturity date and pay the buyer a stated rate of interest until maturity. Purchasing a corporate bond does not give the buyer a stake or an ownership in the company, unlike when one purchases equity stock in a company. Key Features:

  • Corporate bonds carry higher risk than government bonds as their repayment depends on the company’s ability to service debt. Therefore, they pay a higher return than government bonds to compensate for the risk. Since the yield is majorly a composition of the risk free rate and a credit spread, credit ratings form an integral part in distinguishing corporate bonds.
  • Credit ratings are given from AAA to D as specified by the credit rating agencies, depending on a variety of fundamental factors pertaining to the company. Credit ratings indicate the level of risk of default on the issuer, with AAA indicating highest safety and D indicating a very high probability of default on the part of the issuer. Investment-grade bonds are those corporate bonds that have a credit rating higher than BBB-. Corporate bonds with better ratings would provide a lower return as compared to the ones with poorer ratings as the risk involved in the former would be lower.
  • Corporate bonds can be Secured, Unsecured or Guaranteed.
  • All terms and conditions and details regarding a corporate bond are defined in a Term Sheet or Offer Document at the time of issuance.
  • The day count convention used is either actual/365 or actual/actual depending on whatever is specified in the term sheet.
  • All the entities (participants) desirous of settling trades in corporate bonds should be registered either with NSCCL or ICCL. Entities carrying out settlement on behalf of participants shall also be registered as participants.
  • The settlements of corporate bond trades are carried out between Monday to Friday for three settlement cycles viz., T+0, T+1 and T+2.
Major types of Corporate bonds in India:

Convertible bond

These are debt instruments that can be converted into a predetermined number of common stock or equity shares of the issuing company. The market price of convertible bonds takes the expected stock price at conversion into account. Also, due to this choice of conversion, these bonds offer investors with slightly lower interest rates.

Non-convertible bond

These are unsecured bonds that cannot be converted to company equity. Therefore, they offer a higher interest rate as compared to convertible bonds.

Fixed rate bond

These bonds pay a fixed coupon to the investors at regular intervals. These can be either short term or long term, and have a fixed tenor. It is ideal for those who want to earn an assured stream of income over a specified term.

Floating rate bond

The interest rate fluctuates based on the benchmark on which the bond is drawn. The coupon rate is reset periodically. Interest rate risk is largely mitigated as these bonds will pay higher return when prevailing rates are high.

Zero-coupon bond

Such bonds pay no interest during the life of the bond. Investors buy the zero-coupon bond at a discount to the face value. At maturity, the investor receives the face value of the bond. The difference between the discounted price and the face value is, thus, the return on this investment.

Perpetual Bond

This is a fixed income security with no maturity date. The bond is not redeemable, but it pays a regular stream of interest to the holder in perpetuity. In India, banks issue perpetual bonds to meet their long term capital requirements. In banks, these bonds come under the Additional Tier I bonds. This means that in the case of liquation, the banks pay the perpetual bondholders last but before equity investors. The issuer has the option to ‘call back’ the bond. They usually do it if they can refinance the issue at a cheaper rate, especially when interest rates are declining.

Tax-free bond

Tax-free bonds are issued by public sector companies with an aim to raise funds for specific projects. Therefore, they are safer and carry low default risk. The interest income earned from these bonds is not taxed. They carry a fixed rate of interest for a fixed term. On maturity, the principal is returned to the investor.

Why invest in corporate bonds?

  • Corporate bonds offer higher yields as compared to government bonds or CDs.
  • Corporate bonds can be a lower-risk way to gain exposure to corporates than equities because they pay investors relatively stable cash flows.
  • Corporate bonds are evaluated by rating; the higher the rating, the safer the investment.
  • Corporate bonds provide an opportunity to choose from a variety of sectors to meet your investment goals thus providing good diversification benefits.
  • Investors have a platter of different structures of bonds to choose from to suit their investment needs.

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