What are Corporate Bonds?

Story: Cyberstark Industries

“Cyberstark Industries” was a large corporation that was growing quickly and required additional funding to support its expansion goals. However, the CEO of Cyberstark didn’t want to dilute the ownership of the current shareholders by issuing more stock. Instead, the CEO decided to issue bonds to raise the needed capital. Cyberstark Industries issued Rs.100 million worth of corporate bonds to a group of investors. These investors became the bondholders of Cyberstark and were entitled to receive a fixed amount of interest, known as the coupon rate, on the bond’s face value annually.

On the maturity date, Cyberstark had to repay the bondholders the full amount of the bonds they had purchased. In exchange for lending the company money, the bondholders received a guaranteed return on their investment in the form of coupon payments. In the end, Cyberstark was able to finance its expansion using the bond proceeds and the bondholders received a steady stream of income from their investment.

This illustrates the concept of what are corporate bonds and how it can be used as a way for companies to raise capital without diluting shareholder ownership.

What are Corporate Bonds?

A corporate bond is a type of debt security issued by a corporation to raise capital. Investors who purchase a corporate bond lend money to the company for a specified period and receive periodic interest payments. At the end of the bond term, the company repays the bond’s principal. As of March 31, 2024, the Indian bond market stands at a staggering $2.59 trillion, with corporate bonds accounting for $567 billion, or 21.90% of the market (Source: CCIL and SEBI). Corporate bonds provide an efficient way for companies to raise capital, fostering economic growth and financial inclusion.

Why Corporates Issue Bonds

Corporates issue bonds as a way to raise capital without diluting ownership. Instead of approaching banks or issuing equity, companies borrow money directly from investors by offering fixed interest payments over a specified period. This method allows firms to fund business expansion, refinance old debt, invest in infrastructure, or meet working capital requirements. Bonds can be tailored in terms of tenure, coupon rate, and structure to match the company’s financial strategy. For example, issuing long-term bonds might help lock in lower interest rates, while short-term bonds can address immediate cash flow needs. Bonds also diversify the funding mix and often come with fewer regulatory hurdles compared to equity issuance.

Understanding the Quality of Corporate Bonds

The quality of corporate bonds is primarily assessed through credit ratings provided by agencies like CRISIL, ICRA, or CARE. These ratings evaluate a company’s financial strength and ability to repay its debts.

• High-Grade Bonds: Issued by financially strong corporations with low risk of default.
• Speculative Grade Bonds: Higher risk but offer higher returns to compensate investors.
  Understanding bond quality is crucial because it directly influences the interest rates and potential returns. In the context of the corporate bonds definition, the issuer’s credibility plays a major role in investment decision-making.

Types of Corporate Bonds

There are several types of corporate bonds catering to different investor needs:

• Secured Bonds: Backed by specific assets of the company.
• Unsecured Bonds: Also known as debentures, not backed by any asset but rely on the issuer’s reputation.
• Convertible Bonds: Can be converted into equity shares of the issuing company under specified terms.
• Callable Bonds: Issuers can redeem these bonds before the maturity date at a predefined price.

Knowing the different types is important to understand how do corporate bonds work in various market scenarios.

Features of Corporate Bonds

Corporate bonds are debt securities issued by companies to raise capital. Here are some key features:

Fixed Interest Payments: Corporate bonds provide regular interest payments, semi-annually or annually depending upon the issuer or type of bond.

Credit Ratings: Credit ratings are evaluations done by credit rating agencies that show how reliable issuers are at repaying debt. They help investors understand the risk involved in investing in these products.

Maturity Dates: Corporate bonds have specified maturity dates when the principal amount is repaid.

Marketability: These bonds can be bought and sold in the secondary market, offering liquidity to investors.

Risk and Return: Bonds with higher ratings usually offer lower yields, whereas bonds with lower ratings may provide higher returns to offset the increased risk.

Why Corporates Sell Bonds

Corporations issue bonds for several strategic reasons:

• Raise Capital: For expansion projects, mergers, or new investments without diluting equity.
• Refinance Debt: Replace older, higher-interest loans with new, lower-cost debt.
• Flexibility: Bonds provide a flexible financing option compared to bank loans.
  Selling bonds allows corporations to access large sums of money quickly, while investors benefit from interest income based on the meaning of corporate bonds.

How Do Corporate Bonds Work?

Corporate bonds are issued by companies to raise capital for various purposes, such as funding business operations, financing expansion plans or refinancing existing debt. When a company issues a bond, it is essentially borrowing money from bondholders, who then become creditors of the company. Bondholders receive periodic interest payments, which can be monthly, quarterly or semi-annually based on a fixed interest rate that is specified in the information memorandum. The face value of the bond, also known as the principal amount, is repaid at the bond’s maturity date.

Corporate bonds are typically rated by credit rating agencies such as CRISIL, ICRA, CARE, etc to help investors assess the creditworthiness of the issuer. Higher-rated bonds are considered less risky, while lower-rated bonds carry relative credit risk and may offer higher yields to compensate for the added risk. The price of a corporate bond can fluctuate based on changes in market conditions and the financial health of the issuer. If a company’s financial performance deteriorates, its credit rating may be downgraded, which can cause the price of its bonds to decrease. On the other hand, if the company’s financial performance improves, its credit rating may be upgraded, which can cause the price of its bonds to increase. Overall, investing in corporate bonds can provide a source of fixed income for investors, but it also carries the risk of interest and credit risk. As with any investment, it is important for investors to carefully consider the creditworthiness of the issuer, the terms of the bond and the market conditions before investing in corporate bonds.

Risks & Factors Affecting Bond Prices

Corporate bonds carry several risks, such as credit risk (possibility of default by the issuer), interest rate risk (bond prices fall when interest rates rise), and liquidity risk (difficulty selling before maturity). Several market factors influence bond prices. A key one is interest rate movement—when interest rates rise, existing bonds with lower coupons become less attractive, causing their prices to drop. Conversely, when rates fall, bond prices tend to rise. Inflation expectations, economic conditions, changes in credit ratings, and issuer performance can also impact pricing. Investors should evaluate these risks in relation to their financial goals and time horizon.

How Do Corporate Bonds Make Returns?

Corporate bonds generate returns for investors through:

Coupon payments: Regular interest payments made by the issuer, on a monthly, quarterly, semi-annual, or annual basis.

Capital Gains: If a bond is sold before maturity at a higher price than its purchase price, the investor makes a capital gain.

Reinvestment: Interest payments can be reinvested to earn additional returns.

Benefits of Investing in Corporate Bonds

1. Relatively stable income: Corporate bonds provide a steady stream of income in the form of regular coupon payments.
   
2. Diversification: Adding corporate bonds to your portfolio can help diversify your investments and reduce overall portfolio risk.
   
3. Potential for higher returns: Corporate bonds can offer higher returns compared to savings accounts or government bonds.
   
4. Credit quality: High-rated corporate bonds are considered to be low-risk investments.
   
5. Liquidity: Corporate bonds are typically traded on major exchanges, providing investors with a high degree of liquidity.
   

Factors Influencing the Price of Corporate Bonds

Several factors impact the price of corporate bonds in the market:

• Interest Rate Movements: Rising rates generally decrease bond prices and vice-versa.
• Credit Rating Changes: Downgrades can lower a bond’s market value; upgrades can increase it.
• Inflation Expectations: High inflation can reduce the real returns of bonds.
• Economic Conditions: A strong economy typically improves bond performance, especially for high-yield bonds.

Understanding these dynamics is crucial when assessing the real value and risks associated with corporate bond investments.

How to Buy Corporate Bonds?

By doing the following actions, you can purchase corporate bonds using the IndiaBonds platform:

1. Visit IndiaBonds.com and register to create an account.
   
2. Post-Registration, finish the KYC process in just 3 minutes. It’s paperless, doesn’t require uploads, digitally confirms you, and all you have to do is add your bank and demat details.
   
3. You are now prepared to begin investing in the bonds of your choice, either on the primary market or the secondary market. Even the payment is made online and goes directly to the clearing house of NSE/BSE for settlement, which credits the bond to your demat account.

It’s important to note that bonds are subject to market risk and credit risk, so you should conduct thorough research and consult with a financial advisor before investing in bonds.

Conclusion

The corporate bond market in India provides a platform for companies to raise capital by issuing debt securities in the form of bonds. These bonds are sold to institutional and individual investors and offer fixed returns over a specified period. The primary market for corporate bonds is through private placement, while the secondary market is through exchange platform/OTC. Corporate bonds offer investors fixed returns and diversification opportunities. The Securities and Exchange Board of India (SEBI) regulates the corporate bond market. With the growth of infrastructure financing and non-banking finance companies, the market has seen increased activity in recent years. Overall, the corporate bond market plays a vital role in supporting the growth and development of businesses and providing investment opportunities for individuals and institutions.

FAQs

1. What is a corporate bond and how does it work?

A. A corporate bond is a debt security issued by a corporation and sold to investors. It represents a loan made by the investor to the corporation, with the bond serving as evidence of the debt and specifying the terms of the loan, such as the interest rate and maturity date. The corporation promises to repay the principal amount of the bond at maturity and pay interest to the bondholders periodically.

2. Are corporate bonds safe to invest in?

High-rated corporate bonds from reputed issuers are considered relatively low risk. However, all corporate bonds carry some degree of credit risk, and it’s important to review the issuer’s rating and financials before investing.

3. What are the advantages of investing in corporate bonds?

They offer predictable income, higher returns than government bonds or FDs, and diversification in a portfolio. Listed bonds also offer liquidity in the secondary market.

4. What are the risks associated with corporate bonds?

Key risks include credit risk, interest rate risk, and liquidity risk. Lower-rated bonds may offer higher returns but come with a greater chance of default.

5. How do corporate bonds differ from fixed deposits (FDs)?

FDs are bank products with fixed returns and insurance up to ₹5 lakh. Corporate bonds are market-traded instruments with variable returns and credit risk based on the issuer.

6. What is the minimum investment required for corporate bonds in India?

Typically, ₹10,000 is the minimum investment for listed corporate bonds, although it can vary by issuer and platform.

7. How can I buy corporate bonds online in India?

You can buy them via SEBI-registered Online Bond Platform Providers like IndiaBonds or through your broker’s trading platform if the bond is listed.

8. What is the tax treatment on returns from corporate bonds?

Interest earned is taxed as per your income slab. Capital gains on bond sale are also taxed—short-term gains at slab rate and long-term gains at 10% without indexation (if listed).

9. Who should invest in corporate bonds?

Investors seeking fixed income with moderate risk, better returns than FDs, and portfolio diversification may consider corporate bonds.

10. Can I sell corporate bonds before maturity?

Yes, if the bond is listed on an exchange, you can sell it in the secondary market. Liquidity varies by issuer and demand.

11. What is the typical duration of a corporate bond?

Corporate bonds usually range from 1 to 10 years, though some can be shorter or longer depending on the issuer’s borrowing needs.

12. What is a company bond?

A. Corporate bonds are also referred to as company bonds.

13. Who should ideally invest in corporate bonds?

A. Corporate bonds are typically recommended for investors seeking:

• Portfolio Diversification
• Fixed Regular Interest Income
• Medium to long-term investment
• A higher yield compared to government bonds & bank FDs
• Low volatility in portfolio (unlike equity)

However, it’s important to consider the creditworthiness of the issuing company and the market conditions before investing in corporate bonds.

14. What is the difference between a corporate bond and a corporate bond fund?

A. A corporate bond is a debt security issued by a corporation, typically paying periodic interest payments and returning the face value of the bond at maturity. A corporate bond fund is a type of mutual fund that invests in a diversified portfolio of corporate bonds, with different maturities providing exposure to the debt of multiple companies. One of the key differences is that a corporate bond provides the bondholder with recurring income in the form of interest payments, whereas a corporate bond fund does not guarantee returns. Returns fluctuate depending on the market price of the underlying bonds.

15. Why invest in corporate bond?

A. Corporate bonds might be a great option if you want to reduce the risk of capital losses while earning predictable income at regular intervals. Additionally, corporate bonds offer superior yields, liquidity, and portfolio diversification than fixed deposits.

16. Is corporate bond a good investment?

A. Corporate bonds can be a good investment for those seeking regular income, portfolio diversification and higher returns compared to fixed deposits. However, it’s crucial to consider the issuing company’s creditworthiness and align investments with your financial goals rather than chasing high returns.

Disclaimer: Investments in debt securities/ municipal debt securities/ securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully.