Introduction
Corporate bonds
serve as a key tool for companies to raise capital. These debt securities come
with defined repayment terms, allowing companies to borrow money from investors
and return it with interest over time. Whether you are exploring investment opportunities
or simply looking to diversify your portfolio, understanding how corporate
bonds work and their role in the financial ecosystem can help you make informed
decisions. Keep reading on to know what corporate bonds mean, how they work,
their features and factors to consider.
What are Corporate Bonds and How Do They Work?
Corporate bonds are debt securities issued by companies looking to raise capital. These bonds come with clearly defined repayment terms. While some are redeemed with a single bullet payment at maturity, others may be repaid in tranches. In many cases, corporate bonds provide periodic interest payments.
Why Do
Companies Issue Corporate Bonds?
Each company has a clearly defined line of business and growth strategy, necessitating capital at various times. While equity provides a source of long-term capital, companies often require short-term capital as well, which can be raised through issuing bonds. This type of financing is generally considered a more flexible alternative to equity, especially for short-term needs. Capital raised from bonds can be used for various corporate purposes such as purchasing raw materials, paying salaries, funding acquisitions, or refinancing high-cost loans. Companies can also use proceeds from raising corporate bonds to fund a growth project. The cash flows from business are used to service the interest obligation on corporate bonds.
Why Do
Investors Buy Corporate Bonds?
Corporate bonds issued by reputable companies are often considered by fixed-income investors. Depending on the features of the corporate bond, as an investor, you can get regular income in the form of interest paid by the issuer. Investors seeking safety of capital may choose to invest in corporate bonds issued by high-quality corporations with strong business fundamentals.
Issuance of
Corporate Bonds
Corporate bonds are issued either through private placements or bond public issues. These bonds can be listed on stock exchanges and can be held in demat form. The issuer specifies the face value of the corporate bond at the time of issuance. The coupon is clearly specified as a percentage of the face value. For example, a corporate bond with a face value of ₹1 lakh offers to pay interest (coupon) at the rate of 8% per annum. In that case, an investor holding the said corporate bond is entitled to receive ₹8,000 towards interest.
Corporate bonds can be issued by privately held corporations, publicly listed companies or by companies backed by governments – public sector undertakings.
At the time of issuance, the company issuing the bond may choose to insert a call or put option in the corporate bond. A call option allows the issuer to call back the bond. A put option gives the buyer of the bond the right to sell the bond back to the company issuing it.
Features of
Corporate Bonds
Now that you know the meaning of corporate bonds and how they work, let’s go over their key features:
• Fixed Interest Payments: You stand to receive regular interest payments which are typically paid semi-annually or annually, depending on the bond or issuer.
• Credit Ratings: Credit rating agencies assess the issuer's ability to repay debt, helping you gauge the risk associated with the investment.
• Maturity Dates: Corporate bonds come with defined maturity dates, at which point the principal is repaid.
• Tradeability: You can buy and sell these bonds in the secondary market.
Factors to
Consider When Investing in Corporate Bonds
While investing in corporate bonds in India, you ought to consider the following parameters:
• Credit Ratings
Corporate bonds may carry higher credit risk than debt security issued by the government. Credit rating agencies assign ratings to corporate bonds depending on their view of the debt servicing ability of the corporation. A credit rating of AAA is considered the best for corporate bonds and denotes the highest safety of timely payment of interest and principal.
• Interest Rate Risks
When investing in corporate bonds, you are also exposed to interest rate risk. Long-term corporate bonds tend to be more sensitive to interest rate fluctuations. As interest rates rise, the price of corporate bonds generally falls; conversely, when rates decline, bond prices typically increase.
• Returns
Since credit ratings influence the returns payable on corporate bonds, you need to pay heed to the credit rating and the tenure of the bond. Corporate bonds with AA and lower ratings offer higher rate of interest as compared to their AAA (and AA+) rated counterparts to compensate for the extra credit risk the investor is exposed to.
• Interest Payout Frequency
The corporate bonds may choose to pay interest periodically – monthly, quarterly, semi-annually or yearly.
• Credit Spread
The difference between the yield of a corporate bond and the yield on a government security is termed a credit spread. The returns on corporate bonds are usually in sync with prevailing credit spreads for bonds with respective credit ratings.
• Credit Rating Changes
You may see the price of a corporate bond appreciate if a credit rating agency upgrades the credit rating of a corporate bond. For example, a change from AA to AAA credit rating. You must also note that a downgrade in credit can pull down the price of the bond.
• Liquidity
Corporate bonds are listed on stock exchanges, and some are actively traded. Bonds with high credit ratings issued by reputable companies are preferred by many investors and are generally more liquid in the secondary market. Additionally, liquidity in the Indian corporate bond market has been improving, enhancing the ease of trading these instruments.
Comparison Between Stocks and Corporate Bonds
Stocks offer proportionate ownership claims in the business of the company, whereas corporate bonds are debt issued by a corporation. Stocks are risky investments, as the shareholders are paid at the last, in case the company goes into liquidation. Bondholders precede the stockowners in company liquidation, whereas the secured corporate bondholders precede those with unsecured bond holdings.
Owning stock of a company allows you to participate in the upside if the company does well and the corporate earnings grow. The investors in corporate bonds do not participate in the growth of the company. Their reward is restricted to the interest payout agreed upon at the time of issuance of the bond.
Add Corporate Bonds to Your Portfolio with Altifi
Given the various features offered by these instruments, you may consider on how to invest in corporate bonds and include them in your portfolio for better risk-adjusted returns. Altifi allows you to invest in corporate bonds offered by a wide range of companies. With its range of fixed-income instrument offerings, you can diversify your portfolio with government securities, corporate bonds, t-bills, commercial papers, etc. Download the app or simply register on the web platform.
*Disclaimer: The contents of this article should not be construed as tax or financial advice. Readers should seek advice from their tax or financial advisor before making any investment decision.
Reference:
https://investor.sebi.gov.in/pdf/reference-material/corporatebonds.pdf