Among the most efficient financial vehicles, bonds provide a steady stream of income to the investor without exposing them to a huge loss of capital. Bonds offer investors the best chance to systematically hedge against the decline of other asset classes. Investors love corporate bonds more than any other kind of bond. However, as there are different types of corporate bonds, it is important to learn about each one of them.
The issuer and holder of bonds enter into a loan agreement that specifies the repayment schedule (debt servicing) and the date of maturity. Both discounted and premium versions of these are available, and they both have a face value (principal) that must be returned at maturity. A bond is a type of fixed-term debt instrument that the issuer issues to fund a particular project. Until the bond matures, the bondholder receives interest payments based on the coupon rate. Bond prices are inversely related to market interest rates and depend on several factors such as the issuer's credibility, maturity, and interest rates on the market.
The government or large corporations typically issue bonds for their huge capital needs. Both openly traded and over-the-counter options are available. Fixed income instruments used to be the name for bonds because of the fixed coupon rates that came with them. Interest rates that fluctuate or are subject to change are also commonplace nowadays.
Companies and other private entities can raise capital from the general public through the issuance of corporate bonds. Bondholders are individuals who lend money to a corporation by purchasing bonds issued by that company.
When the bondholders invest in the corporate bonds of a company, the company makes a legal commitment to provide regular interest payments on the principal amount based on the corporate bond rates. In addition, investors expect the corporation to repay the principal amount upon maturity. Although they come with a lot of perks, corporate bonds still have to pay interest (unless it's a zero-coupon bond) and repay the principal.
The Indian corporate bond market may be tiny, but it has a huge influence on the global financial system. Since 2008, India has witnessed increased investment inflows, mainly due to simpler investment regulations, easier clearing and payment of deals. Another factor that has contributed to the expansion of India's corporate bond market is the introduction of exotic bonds, such as masala bonds and green bonds.
While the outstanding corporate debt reached 35.1 lakh crore rupees in FY 2020-21, the primary bond issuance was 7.8 lakh crore rupees, representing 18.2% of India’s GDP. Crisil projects that the outstanding corporate bond market would double to Rs 65.70 lakh crore by 2025, thanks to the rising demand in India's corporate bond market.
There are different types of corporate bonds in India that investors can invest and trade in to realise regular interest payments with the promise of principal repayment:
Zero-coupon Bonds: These sorts of bonds do not pay regular interest to the bondholders but are accessible at a discount. At maturity, the only payment is made to repay the principal amount. Bondholders are obligated to pay taxes on the value of the accumulated interest, nevertheless.
Convertible Bonds: They are hybrid bonds that have the option to be converted to stocks based on the underlying asset of the bond. Bondholders become shareholders with bond conversion, and the issuer is relieved of future interest payments.
Floating Rate Bonds: Floating rate bonds have fluctuating interest rates and provide different interest payments to the bondholders every time. The coupon rate is based on the prevailing interest rates in the market and the ability of the corporation to offer a particular interest to the bondholders.
Fixed-Rate Bonds: Fixed-rate corporate bonds, also called vanilla bonds, pay the bondholders a predetermined amount as interest. Corporate bonds have a fixed coupon rate that is determined when the bonds are issued and remains constant throughout their term.
Investment Grade Bonds: Corporate bonds are graded depending on their credit ratings. Bonds issued by corporations with a credit rating between BBB-and AAA are considered investment-grade bonds. Companies issuing investment-grade bonds are in a solid financial position and are highly unlikely to default on their payments.
Junk Corporate Bonds: Junk bonds are a type of bond that carries a higher risk of default. The issuer of such bonds may not have the appropriate cash flow to pay regular interest or refund the principal amount to the bondholders at the time of maturity. Bonds issued by financially troubled corporations are known as trash bonds and typically have higher yields. This is because junk bonds can only offset the risk of default with a high yield.
Although bonds carry lower risk than other investment instruments in the financial market, corporate bonds carry a higher risk than government bonds. It is because a government is highly unlikely to default on interest payments owing to a lack of cash flow. However, corporate bonds are issued by private companies and the promise of regular interest payments and principal repayment is kept until the company has positive cash flow and is profitable. In the case of the company having negative cash flow, it may default on the interest payments or repay the principal amount at the time of maturity.
The likelihood that a bond issuer will not pay its interest or principal is known as the default rate. The investors can calculate the default rate attached to the types of corporate bonds using two methods:
Dividing the number of issuers of corporate bonds who have defaulted on payments by the total number of corporate bond issuers at the beginning of the year. For example, if 500 issuers have defaulted and the total number of issuers at the beginning of the year was 1000, the default rate would be 50%.
Taking the rupee value of the whole number of defaulted bonds and dividing the value by the total par value of all the existing bonds.
The default rate of corporate bonds assists investors in guaranteeing they do not invest in bonds that have a high probability of defaults. It can force the bondholders to incur huge losses and lose the principal amount financed in the first place.
As there are numerous types of corporate bonds trading in India, you can compare all of them based on their face value, coupon rate, and credit ratings to invest in an ideal bond to ensure you achieve your financial goals.
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