The corporate bond market in India – an investor’s guide

Before we start talking about the corporate bond market, let’s educate ourselves on “Bond”. What exactly ‘bond’ means and where does this bond word come from? While digging on the history of bonds I came across this. VOC, a Dutch East India Company, was the first company to issue bonds and shares to the general public.

A ‘bond’ refers to a fixed income investment in which an investor loans money to an entity. Such an entity could be a corporate or a Government. These entities borrow fund for a fixed period of time at a variable or fixed interest rate.

Now the question arises who can issue bonds? The answer is – companies, municipalities, states and sovereign governments issues bonds.  They raise money through it and finance the projects & other activities that are been lined up.

This is a brief definition of a bond. Now it would be easier to understand what “corporate bond” and “corporate bond market” means.

Corporate bond market – what it means to an investor?

Corporate bond means the issuance of a debt security by corporations and further selling it to investors. Backing up for the bond is usually the payment ability of the company. Payment ability normally is the money that has to be earned from future operations.

The corporate bonds are riskier than government bonds. Government bonds or gilt securities may result in higher interest rates than on corporate bonds. Even for companies who have blue-chip credit qualities. Usually, companies issues these bonds to raise money for various purposes. The purpose may be building a new plant, purchasing new equipment or maybe for business growth. One common thing with such corporate bonds is that companies raise money through this instruments mostly for long-term investments.

You may consider corporate bonds to be safest of all investment. It can give maximum return to the investors with time. The more is the maturity period, higher is the return. The maturity period can be anywhere from less than 5 years to more than 12 years.

Some important terms related to the corporate bond market in India 

Some of the important terms that relate to the corporate bonds are:

• Nominal value – It is the price at which the bonds are sold the first time in the market.
• Interest rate – This is the amount that is paid to the bond owner. Corporate bonds interest rates are usually fix.
• Redemption date – The date on which repayment of the nominal value of the bond is done to the bondholders.
• Par value of a bond – It is the amount the company pays to the investors after maturity od the bond.
• Current yield – The annual return an investor makes from investing in a bond
• Yield to maturity – It is the in-house rate of return of all cash flows in the bond investment. It includes present bond price, coupon payments till maturity and the principal amount.
• Tax – There are two types of tax. Firstly, if an investor holds the corporate bond for less than 3 years then he/she has to pay short-term capital gains tax. This is based on different tax slabs. Secondly, if you hold a bond for more than 3 years then you need to pay long-term capital gains tax. Currently, it is 20% of the gain and is mandatory.
• Exposure & allocation – Corporate bonds usually have small exposures due to less credit space available. Corporate bonds normally allocate 5% approximately to the sovereign fixed income.

Characteristic features of the corporate bonds

In fact, corporate bonds are a flexible way of raising debt capital by any company. Bond could be secured or unsecured. Any investor needs to decide the priority to take over other debts.

Some corporate bonds are traded on the over-the-counter (OTC) market and offer good liquidity. Liquidity means the ability to rapidly sell the bond for ready cash. Usually, the interest on bonds has to be paid in every six months (semi-annual payments).

When bond prices decline, the interest rate increases because the bond costs less. But the interest rate remains the same as its initial offering. Conversely, when the price of a bond goes up, the effective yield declines. The long-term bonds usually offer the highest interest rate because of the unpredictability of the future.

Corporate bonds are normally experienced by a very low incidence of default over time. High rated bonds have a low chance of risk. Rating agencies like ICRA, CARE and CRISIL rate corporate debts.

Does the corporate debt market help in economic growth? 

The equity market in India is well developed and plays a vital role in the growth of Indian economy. In India, the corporate bond segment is still at aborning stage and would require a lot of actions in taking up it to the global standard. Corporate bond plays a critical role in supporting economic development at both levels- macroeconomics and microeconomics.

A well-developed corporate bond market can be the optimal alternative, to support the financing requirement for infrastructural development and relieving the banks from the issues of long-term financing.

It spreads out huge financing risk in strengthening India’s bank-based financial system which would allow corporate borrowers to hit on the low-cost market, enabling investors to earn fixed but higher returns and finally ensuring overall growth of the economy.

Why corporates raise funds through bonds route

The motive behind corporate bonds is that the corporation issues bonds to fund their operations. There can be two ways to raise the fund for the company. This is by selling a share by issuing stock or to take debt by issuing bonds

Corporate bond market belongs to the capital market. Corporate bond markets mostly prove to be boon for infrastructure projects and for financial requirements of small as well as mid-level enterprises because they need long-term finance which is not possible from banks to provide. For say, the corporate company puts up heavy demand for bank funds, which may move small enterprises out of funding. Then, in this case, it would be prudent to move towards financial system, where corporate bond market plays a vital role.

Four different types of corporate bonds

Numerous characteristics of debt have resulted in variations in the issuance of the bonds. here are the four major types of bonds –

1. Convertible bonds – Investing in convertible corporate bonds are often said to be investing in two by paying for one. The one who invests in convertible bond gets bond security along with the interest payment on a regular basis. These bonds also give the right to convert the bond into shares of the company at its face value.
2. Junk bonds – It is said to be low rated bonds with a higher rate of interest as well as high risk. When an investor buys this bond, then they actually give the loan to the company. The company in return offers a certain rate of interest to the investor which can be higher than any other investment.
3. Zero coupon bonds – It can also be said to be the accrual of the bond. These bonds do not pay any amount for the coupon but are traded at a high rate of discount. The return is possible in terms of profit that comes with the maturity of the bond.
4. Strips bonds – These bonds are created by stripping of coupon and is a kind of debt securities (a negotiable or tradable liability or loan). The investors have the privilege to choose the interest rate on strip bonds or principal of the bond. These bonds are also called treasury bonds (an interest-bearing bond issued by the US).

Which risk is crucial in the case of corporate debt in India? 

The most important risk to the bondholder is that if the company fails to make payments. Then, in this case, the company will default on its bonds. The “default risk” makes the creditworthiness of the company. Meaning the ability to pay its debt obligations on time. This has an important concern for bondholders. Since the default risk for corporate bonds is higher, so they are usually issued at a higher discount than government bonds.

Importance of credit ratings for Indian corporate bonds

The rating of any investment means the credit-worthiness of corporate or government bonds. These ratings are published by credit rating agencies which further helps the investment professionals to assess the probability of repayment of debt. Rating process helps the investors about the creditability of the bond issuing company along with the risk factors in the investment.

The agency who are usually involved on credit rating procedure frequently reviews the rating given to particular instrument, which would help investors to decide whether to keep the bond or sell it.

After the procedure is done, the investors get assured about the investment for say, they take decisions on the basis of higher credit rating and less risk of bankruptcy. This is said to be the assurance of safety.

As we all know that there can be various bonds to be invested but one can invest in only one or may two bonds. When there is a huge range of choices then these ratings help the investors to pick the one with the less risk.

Credit rating saves investors’ time and efforts. The investors do not have to research the companies that offer bonds. Credit rating agencies analyze the financial strength of the issuer company. It helps the companies to improve its corporate image so that the investors can trust the company.

The credit rating reports that are made by the agencies are easier to understand, it is helpful for financial institutions, banks as well as the general public. These agency rating reports act as a marketing tool for the companies that helps in gaining the trust of the investors.

The credit rating report also helps the company in growth and expansion, higher the credit rating more is the expansion. The rating is helpful for both, companies as well as investors.

How corporate bonds differ from fixed deposits and debt mutual funds?

Now, if we compare fixed deposit and debt mutual funds with corporate bonds –

• Fixed deposit – It is a financial instrument offered by banks which offers investors a high rate of interest on their savings as compared to any other regular saving accounts, till the maturity date. The criteria for FD is so that the money cannot be withdrawn before the maturity period, if done so then the investor will not get the amount with interest added. The investor will just get the principal amount. The interest rates vary between 4% to 7.25% and the tenure can be from 7, 15 or 45 days to 1.5 years. The maturity period can also go up to 10 years. FD is beneficial because the investors can avail loan against FDs up to 80-90% and rate of interest on the loan can be as less as 1-2%. Deduction of tax is done on FDs if the interest paid back to the investors exceed Rs. 10000 in a financial year. This process is said to be Tax deducted at source and currently fixed at 10% of interest. In case you didn’t furnish your pan details then flat 20% will be deducted on your interest payments for FDs.
• Debt mutual funds – The mixed investment of debt or fixed income securities such as treasury bills, government securities, and money market instruments are called debt mutual funds. Buying a debt instrument is equals to giving the loan to issuing entity. People invest in debt funds because of the interest income and capital appreciation. Investors get pre-decided interest on debt securities after the maturity period and so these investments are said to be “fixed –income securities”.

As an investor how you can invest in corporate bonds in India

Further, as an investor, you can invest in two ways. Firstly, investors can buy individual corporate bonds through brokers. Taking up this route means as an investor you need to research on the companies that offer corporate bonds.

After that, it is your responsibility to ensure that they do not get into any default risk. Also, you need to ensure that your portfolio is adequately diversified among bonds of different companies, sectors, and maturities, in order to optimise the bond returns.

Secondly, invest via mutual funds or exchange-traded funds that focus on corporate bonds. Funds have the different set of risks than individual bonds, the benefits of diversification and professional management is there for this route of investment.

Why you should prefer bond rather than equity of a company?

We learn that the corporate debt market plays a vital role in the overall economic development of the nation. Now as an investor do you need to have an investment in such bonds? Let us explore this.

With time corporate bond has offered investors attractive returns for relevant risks. For further understanding, it would be helpful if we compare them with stocks.

If we buy a share of common stock, we own equity in the company and receive dividends declared and paid by the company. Whereas, if we buy a corporate bond, we do not own any equity in the company.

The one who buys bond will receive only principal amount with interest, no matter how profitable the company becomes or how high its stock price rises.

In case, the company faces the financial crisis, it would have a legal obligation to make timely payments of interest and principal. Unlike, the company would have no obligation to pay dividends to shareholders.

Lastly, in case of bankruptcy, the bond investors prioritize over shareholders in terms of claims on the company’s assets.

Why you should possess corporate bonds in your portfolio?

Usually, an investor should prefer corporate bonds due to the reasons such as-

1. Dependable income – In need of steady income from the investment that is been done, investors move towards corporate bonds. The returns are more prompt than any other investment.
2. Diversity – Corporate bonds offer varieties to the investors in sectors, structures as well as credit-quality characteristics to achieve investment objectives whereas FDs or debt mutual funds do not offer this vast variety to the customers or investors. They have limited investment opportunities.
3. Duration – The maturity period of corporate bonds can be lesser than FDs and debt mutual funds in terms of returns, meaning the time corporate bond investor will take to get maximum return will be less than FDs and debt mutual fund investors. So, the corporates prefer bonds over FDs or debt mutual funds.
4. Attractive yields – Corporate often offer higher yields than comparable-maturity government bonds or CDs. This high-yield potential is normally accompanied by higher risks.
5. Returns – Corporate bond gets higher returns than FDs or any other mutual funds. FDs are not flexible as corporate bonds. There are limitations for FDs or any other mutual funds but corporate bonds are free from such limitations. Corporate bonds have to fulfil a few conditions but that is different from other deposits.

The final verdict

The investors who normally do not consider corporate bonds are risk-averse investors. If we define risk-averse investors- they are such investors who prefer to invest in lower returns with almost no risk.

But as we all know that corporate bonds investment and risk go hand-in-hand which means more or less risk will be there with the bond. More the riskier more is the interest or return.

The risk-averse investors will mostly not prefer to hold the corporate bond in his/her portfolio. They try to avoid risk in their investment, so they usually prefer to invest in government bonds, debentures, and index funds.

Contrary to this, we can get into a conclusion that the investor should rather invest in corporate bonds instead of any such investment. Because if anyone plans to invest means they want some return from their investment or can say good return.

The corporate bonds can be the answer to this, they can be the safest investment. It might have a certain risk but also the highest return on investment.

The companies have the legal obligation to pay to the bondholders whether the company is into profit or loss. To avoid risk there are a credit rating agencies, investors can always depend on the reports to because they do complete research on the company then give the rating.