One of the best financial tools for providing a holder with consistent income without a significant risk of losing the principal amount is a bond. Bonds offer the most systematic investment opportunity among different asset classes to counterbalance the losses of other asset classes. Corporate bonds are the most well-liked type of bonds among investors. But since corporate bonds come in a variety of forms, it's crucial to understand them all.
What are Bonds?
Bonds are contracts for loans that specify the terms of repayment (also known as debt servicing) and maturity between the issuer and the holder. These can be issued at a premium or a discount, and their face value, or principal, is due upon maturity. Bonds are fixed-tenure debt instruments that the issuer issues to fund particular projects. Until the bondholder's maturity, the interest is paid in predetermined installments based on the coupon rate. Bond prices are influenced by a number of variables, including the issuer's reputation, maturity, and market interest rates, and they are inversely correlated with each other.
Bonds are usually issued by governments or big businesses to meet their enormous capital needs. These are available over the counter or through public trading. Bonds were initially referred to as fixed income instruments because they had fixed coupon rates. These days, floating or variable interest rates are also fairly typical.
What Are Corporate Bonds?
Debt instruments known as corporate bonds are issued by private companies to the general public in order to raise capital. Bondholders are those who purchase issued corporate bonds and act as a financial lender to the company.
A company's legal obligation to pay interest on the principal amount principal plus interest at regular intervals determined by the corporate bond rates is fulfilled when bondholders purchase corporate bonds from the company. In addition, the business must reimburse bondholders for their principal after the bond matures. While corporate bond types have many benefits, they still need to pay back principal and pay interest as required by law (except in the case of zero-coupon bonds).
India's Market for Corporate Bonds
Despite its modest size, the Indian corporate bond market has had a significant impact on the financial sector. India has seen an increase in investment inflows since 2008, primarily as a result of streamlined investment procedures and more straightforward trade clearing and settlement. Additionally, the expansion of the corporate bond market in India has been made possible by the issuance of exotic bonds such as green bonds and masala bonds.
The principal amount of bonds issued in FY 2020–21 was Rs 7.8 lakh crore, and the total amount of outstanding corporate debt was Rs 35.1 lakh crore, or 18.2% of India’s GDP. Crisil has forecast that by 2025, the outstanding corporate bond market in India will have doubled to a value of Rs 65.70 lakh crore, owing to the country's growing demand for corporate bonds.
Types of Corporate Bonds
Investors in India have access to a variety of corporate bond options that guarantee principal repayment along with regular interest payments. These include:
Zero-coupon Bonds: These bonds are offered at a discount 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: Convertible bonds are hybrid bonds with the ability to be converted, depending on the bond's underlying asset, into stocks. Bondholders become shareholders upon the conversion of the bonds into common shares, and the issuer is released from future interest payments.
Floating Rate Bonds: Bondholders receive varying interest payments from floating rate bonds, which have variable interest rates. The market interest rates that are currently in effect as well as the company's capacity to pay bondholders a specific interest rate determine the coupon rate.
Fixed-Rate Bonds: Commonly referred to as vanilla bonds, fixed-rate corporate bonds provide bondholders with a fixed amount of interest. During the corporate bonds' duration, the coupon rate remains constant, having been set at the time of issuance.
Investment Grade Bonds: Credit ratings are used to categorize corporate bonds. Corporate bonds classified as investment-grade are those with credit ratings greater than BBB-and up to AAA, the highest possible rating. Investment-grade bonds have a very low chance of payment default because they are issued by stable financial institutions.
Corporate junk bonds: There is an increased default risk associated with junk bonds. When these bonds mature, the issuer might not have enough cash flow to cover principal repayment to bondholders and regular interest payments. Junk bonds, which are bonds issued by companies experiencing financial difficulties, typically have higher yields because junk bonds can only offset default risk through a high yield.
Default Rates: Corporate Bonds
Corporate bonds are riskier than government bonds, even though bonds are still a safer investment than other financial market instruments. The reason for this is that there is very little chance that a government would miss interest payments due to insufficient funds.
Corporate bonds, on the other hand, are issued by private businesses, and they come with a guarantee of consistent principal repayment and interest payments up until the business is profitable and has positive cash flow.
If the business has negative cash flow, it might not pay interest on time or repay the principal when the loan matures. The default rate is the probability that principal or interest payments on corporate bonds will be missed.
There are two ways for investors to find out the default rate for different kinds of corporate bonds:
Dividing the total number of companies that issue corporate bonds at the beginning of the year by the total number of companies that have defaulted on their payments. If there were 500 defaulting issuers out of the 1000 total issuers at the beginning of the year, the default rate would be 50%.
Dividing the total par value of all bonds still in circulation by the total rupee value of all bonds that have defaulted.
High default risk in bonds can be examined by the investors by examining the corporate bond default rate. Bondholders might be forced to incur sizable losses and give up their original investment principal.
There are numerous types of corporate bonds available for purchase in India and you can choose the best corporate bond and ensure that your financial goals are met by evaluating each one based on its face value, coupon rate, and credit rating.
On the primary market, banks, bond dealers, brokerage houses, and stockbrokers are the places to buy corporate bonds.
However, you would first need to open a Demat account before purchasing bonds. It is advised that you consider all of the corporate bond's risks as well as the issuer's creditworthiness.
