Corporate Bonds: Definition, Types, Features, Benefits, Risks & How to Invest

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27 MARCH, 2024

Corporate bonds are a powerhouse in the financial industry because they give companies a reliable funding source. Investors can generate a steady income while diversifying their portfolios with these fixed-income assets. They let companies raise capital for expansion and growth and allow investors to partake in the profits of successful companies.

What is a Corporate Bond?

Simply put, the definition of corporate bonds encapsulates bonds that companies have issued and are often listed in public markets. Compared to bonds issued by other institutions, it is a unique type of bond.

Corporate bonds can be traded actively on the secondary market. When investors purchase one, they lend the company money in exchange for multiple interest payments. These bonds are generally issued to raise capital for business expansion and operations without reducing the company's shareholding.

Types of Corporate Bond Funds

The following are the various types of corporate bondfunds:

Zero-coupon Bonds

These bonds are offered at a bargain but do not pay bondholders regular interest. Repaying the principal at the time of maturity is the only payment made. Bondholders must, however, pay taxes on the interest that has accrued.

Convertible Bonds

These are hybrid bonds with the potential to be converted into equities depending on the bond's underlying asset. Bondholders become shareholders by converting the bonds into common shares, and the issuer is released from future interest payments.

Floating Rate Bonds

Bondholders of floating-rate bonds receive varying interest payments based on changes in interest rates. The existing market interest rates and the company's capacity to pay bondholders a specific interest rate determine the coupon rate.

Fixed-Rate Bonds

Bondholders who purchase vanilla bonds, also known as fixed-rate corporate bonds, receive a fixed amount of interest. Upon issuing these bonds, the coupon rate is fixed and remains constant for the duration of the corporate bonds.

Investment Grade Bonds

Credit ratings are used to categorise corporate bonds. Corporate bonds classified as investment-grade have credit ratings that are more excellent than BBB- and up to AAA, which has the highest attainable rating. Financially sound corporations issue investment-grade bonds with very little chance of defaulting on payment.

Features and Benefits of Corporate Bond Funds

Businesses can raise capital through the sale of corporate bonds for a range of purposes.

The features and benefits of these bonds are listed below:

Corporate bonds frequently offer investors a consistent and dependable income stream through periodic fixed-interest payments.
On the secondary market, they are regularly exchanged. This improves liquidity and permits investors to purchase or sell their bond holdings before the bond's maturity date, allowing them to access their investment capital.
Corporate bonds are a helpful tool for portfolio diversification for investors.
These bonds usually yield higher than government bonds because of the higher credit risk attached to businesses. This increases their attractiveness to investors seeking higher returns.

How do you invest in Corporate Bonds in India?

To initiate investment in corporate bonds, an investor begins the process by opening a Demat account and providing necessary documents such as identity proof, address proof, and PAN card details.

Let’s understand this with an example:

After opening a Demat account, the investor discovers a reputable pharmaceutical company in India that offers corporate bonds. This company boasts of a robust financial history and a bond rating indicating minimal default risk. The bonds are issued with a face value of Rs. 1,000 each, featuring a 5% coupon rate and a 5-year maturity period.

Consequently, when investing Rs. 1,00,000 in corporate bonds, the investor orders 100 bonds, amounting to Rs. 1,00,000 (100 bonds x Rs. 1,000 face value).

Holding these bonds, the investor receives an annual interest income of Rs. 5,000 (100 bonds x Rs. 50 interest per bond) for the subsequent five years. These interest payments are credited to the investor's bank account, which is linked to the Demat account.

Upon completing the 5-year maturity period, the investor receives the face value of the bonds, totalling to Rs. 1,00,000 (100 bonds x Rs. 1,000 face value).

The difference between Corporate Bonds and Stocks -

	Corporate Bonds	Stocks
Ownership	Lenders to the company, debt security	Shareholders, ownership stake in the company
Returns	Fixed interest payments	Dividends (not guaranteed) and capital gains
Risk	Generally lower risk compared to stocks	Higher risk due to market fluctuations
Voting Rights	No voting rights	In shareholder meetings
Maturity	Has a fixed maturity date	Perpetual existence until the company dissolves
Priority in Claims	Higher priority in case of liquidation	Lower priority compared to bondholders
Volatility	Generally less volatile	More susceptible to market volatility
Purpose of Issuance	Capital raising for specific projects	Capital raising for general business purposes
Market Influence	Influenced by interest rates and credit risk	Influenced by market demand and company performance
Conversion Options	Typically, no conversion options	May have conversion options into common stock

Risk Factors and Returns

Bond issuers could fail on their commitments at any time. With longer maturities, this default risk increases exponentially and is worse for securities with lower ratings. An average return of 8% to 10% is expected if your fund manager exclusively invests in highly rated companies. This likewise carries a shallow risk.

Putting money into a well-managed fund with a lower rating can be profitable. For example, corporations often offer higher coupon rates to draw in investors.

On the other hand, there's also a chance that the fund manager's prediction about a firm will come true. Therefore, investors suffer when a company fails to make interest payments or principal repayments or when it receives a further downgrading.

Conclusion

When considering corporate bonds, investors should thoroughly investigate possible issuers, paying particular attention to their credit ratings and financial soundness to assess default risk. Keep a close eye on the issuer's credit standing and financial stability for the duration of the investment. In the ever-changing world of corporate bond investing in India, a knowledgeable and well-rounded strategy increases the possibility of steady returns.

FAQs About Corporate Bonds

Are corporate bonds a good investment?

Compared to stocks, investing in corporate bonds in India can provide consistent returns at a reduced risk. Evaluating the economic climate, interest rate environment, and issuer's creditworthiness is critical. Understanding market dynamics and diversification is essential for making well-informed investment decisions.

What is the meaning of the company bond?

A debt security a business acquires to raise cash is a corporate bond. Investors lend money to the company in return for regular interest payments and the principal repayment at maturity.

What is the average return on corporate bonds?

The credit rating of the issuer, current interest rates, and the state of the economy can all impact the average return on corporate bonds in India. It balances lower risk than equities and fixed income, historically ranging from 7% to 9%.

Are corporate bonds safe in India?

Although there are hazards, corporate bonds can be comparatively safe in India. Evaluate industry stability, the state of the economy, and the issuer's credit quality. Two things are essential: variety and knowledge. Investors can assess the risk involved with certain company bonds by using credit agency ratings.