What Are Corporate Bonds and How Are They Bought And Sold?

Corporate bonds, also referred to as corp bonds, are debt securities issued by corporations to raise funds for various purposes, such as financing operations, expansion projects, or refinancing existing debt. Corporate bonds play a crucial role in the fixed-income market and provide investors with an opportunity to earn fixed-interest income while lending capital to companies.

Investing in corp bonds offers several potential advantages for investors seeking fixed-income securities with relatively stable returns and diversification opportunities. However, understanding key considerations such as types of corporate bonds, credit quality, yield and maturity is essential for investors planning to invest in corp bonds.

Table of contents

1. Types of corporate bonds
2. Benefits of investing in corporate bonds
3. Key things to know about corp bonds
4. How to invest in corporate bonds?
5. Risks associated with corporate bonds
6. Where and how to buy corporate bonds in India

Types of corporate bonds

Corp bonds can be divided into three types:

• Secured bonds: Secured corporate bonds are backed by specific collateral or assets of the issuing company, providing investors with a relatively higher level of security in case of default.
• Unsecured bonds: These corp bonds are also known as debentures. They are not backed by specific assets and rely solely on the creditworthiness of the issuing company. They may offer a higher yield potential to compensate for the increased risk.
• Convertible bonds: Some corp bonds may have a convertible feature, allowing investors to convert their bonds into equity shares of the issuing company at a predetermined conversion price and ratio.

Another broad classification of corporate bonds is:

• Type 1: Invest in high-rated companies such as Public Sector Undertaking (PSU) companies and banks.
• Type 2: Invest in slightly lower rated companies with ratings of AA- and below.

Read Also: Bond Market: Meaning, Rates, Features and Its Types

Benefits of investing in corporate bonds

Investing in corporate bonds may potentially yield the following benefits for investors:

• May provide an income stream through interest payments, which may suit investors seeking relative stability over equity volatility.
• Typically offer higher yields than government bonds to compensate for extra credit risk, helping investors potentially enhance overall portfolio returns while still staying in fixed income.
• Come in multiple tenures (short, medium, long-term), allowing investors to match maturity with goals, and can be accessed either directly or via corporate bond mutual funds for diversification.

Key things to know about corp bonds

If you are looking for corporate bonds to buy, here are 3 things you must know about them:

• Coupon rate: Corp bonds pay periodic interest payments, known as coupon payments, to bondholders. The coupon rate is fixed at the time of issuance and is typically paid semi-annually or annually. Bondholders receive these interest payments as income for lending their capital to the issuing company.
• Maturity date: Corporate bonds have a specified maturity date, at which the issuing company repays the principal amount to bondholders. Maturity periods can range from short-term (e.g., one year) to long-term (e.g., 10 years or more). At maturity, bondholders also receive the final coupon payment.
• Yield to Maturity (YTM): The total anticipated return that you can expect from your investments if the bond is held to maturity and all proceeds are reinvested.
• Credit rating: Corp bonds are assigned credit ratings by credit rating agencies based on the creditworthiness of the issuing company. These ratings assess the likelihood of default and help investors evaluate the risk associated with investing in corporate bonds. Corporate bonds with a higher rating are considered relatively safer investments with lower default risk.

How to invest in corporate bonds?

Investors can invest in corporate bonds through various channels. Each of these avenues offers different opportunities and considerations for investors seeking exposure to fixed-income securities. Here are 4 channels to invest in corporate bonds in India:

• Primary market: Investors can participate in primary market offerings of corp bonds when companies issue new bonds. This typically involves purchasing bonds directly from the issuing company or through underwriters during the initial offering period.
• Secondary market: Investors can buy and sell existing corp bonds from other investors through stock exchanges or Over-the-Counter (OTC) markets.
• Mutual funds: Investors can gain exposure to corp bonds through mutual funds that specialize in fixed-income securities.
• Exchange-Traded Funds (ETFs): Investors can also invest in corp bonds through ETFs that track bond market indices or specific segments of the fixed-income market.

Risks associated with corporate bonds

While relatively safer than equity, corporate bonds still carry some of the risks, such as:

• Credit (default) risk: If the issuing company faces financial stress, it may delay or fail to pay interest or principal. Lower-rated bonds carry higher credit risk.
• Interest rate risk: Bond prices generally fall when market interest rates rise, so investors selling before maturity may face potential losses in a rising-rate environment.
• Liquidity risk: Some corporate bonds, especially lower-rated or smaller issues, may be hard to sell quickly at a fair price in the secondary market.

Where and how to buy corporate bonds in India

• Primary market: Investors may apply during a public issue of corporate bonds or debentures, similar to an IPO, through broker platforms or banks.
• Secondary market: Listed corporate bonds trade on exchanges like NSE/BSE; they can be bought and sold via demat and trading accounts through SEBI-registered brokers.
• Through mutual funds: Debt funds invest in a basket of securities, which can include corporate bonds. Such funds offer professional management and diversification with relatively affordable investment amounts. Corporate bond funds are a category of debt funds that focus primarily on corporate bonds.

Read Also: Callable Bonds: Meaning, Types, and How Its Works?

Conclusion

In summary, corp bonds offer investors an opportunity to receive regular income paid semi-annually or annually based on the coupon rate, and return of principal on the specified maturity date. The bond-issuing companies, in turn, raise capital through investments. Investors with a low-to-medium risk appetite can invest in corp bonds based on their investment objectives and market preferences to diversify their portfolio.

FAQs:

Corp bonds vs. Fixed Deposits: Which one is better?

If you want to compare corporate bonds with FDs solely based on the return potential, then you are likely to see a better return potential from your investment in corp bonds, albeit at a slightly higher associated risk.

For how long should I invest in corporate bonds?

While you must align your investment horizon with your investment goals, it is recommended to stay invested in corp bonds for at least 2 to 3 years.

Where can I buy and sell corp bonds?

You can buy and sell corporate bonds through brokerage firms, online trading platforms, bond funds, primary market offerings, over-the-counter markets, and bond auctions.

How are the corporate bond prices determined?

Plenty of factors play an important role in determining the corporate bond prices such as prevailing interest rates, the credit quality of the issuing company, the maturity period of the bond, supply and demand in the bond market, macroeconomic conditions, and special features of the bond.

What are the risks involved in corporate bonds?

Key risks include default risk (issuer not repaying), interest rate risk (price moves opposite to rates), and liquidity risk (difficulty exiting at desired price), with higher yields generally indicating higher risk.

What is the tax treatment of corporate bonds and bond funds?

For listed bonds, interest is taxed as per the investor’s slab; capital gains from selling before maturity are taxed as short or long-term depending on holding period. For debt mutual funds, capital gains taxation applies on redemption. Under current tax rules, capital gains from debt mutual funds are treated as short-term capital gains and taxed according to the investor’s income tax slab, regardless of the holding period.

How do credit ratings affect bonds?

Credit rating agencies grade bonds (e.g., AAA to junk); higher-rated bonds may usually offer lower yields but lower perceived default risk, while lower-rated (high-yield) bonds pay more but may carry a higher chance of credit events.

Can I sell corporate bonds before maturity?

Yes, if the bond is listed and has market demand, you may sell it on the exchange through your broker, but the sale price may be higher or lower than face value depending on interest rates, credit perception, and liquidity.

Related Searches: