Retail investors are becoming seriously interested in investing in fixed-income instruments like Fixed Deposits (FD), Government Securities (G-Secs), and bonds. We have already discussed many of them, but we haven’t discussed the corporate bonds.
So, in this blog, we’ll break down the nitty-gritty of corporate bonds, how they work in India, their advantages, and disadvantages, and why you should consider investing in them.
Estimated read time: 3 minutes and 22 seconds
Buckle up. Here we go!
What are corporate bonds?
At its core, a corporate bond is a way for companies to raise money. When a company needs funds to expand its operations, launch a new project, or pay off existing debt, they issue bonds to investors.
In return for your investment, the company promises to pay you interest periodically and return your initial investment (the principal amount) when the bond matures.
If you are new to the concept of bonds, check out our bond series, where we have covered the basics of bond investments.
How do corporate bonds work in India?
In India, corporate bonds operate through the debt market. Here’s how it works:
- Issuance: Companies looking to raise funds issue corporate bonds through the debt market. Most companies raise funds through private issues, but recently, we have seen a rise in public issues where these bonds are available for purchase by retail investors like us.
- Investing: When you buy a corporate bond, you’re lending money to the issuing company. In return, you’ll receive periodic interest payments based on the bond’s interest rate (coupon rate).
- Maturity: Corporate bonds have a predetermined maturity date. At the end of this period, the company repays the bond’s face value to the bondholders.
- Secondary Market: If you decide to sell your bond before it matures, you can do so in the secondary market, where the bond’s price can fluctuate based on market conditions and interest rates.
Few more things to know about the Indian corporate bond market. India’s retail bond market is still in a nascent stage. Therefore, the trade volume is low. The minimum investment amount for publicly issued corporate bonds is ₹1,000, but for private issues, it’s ₹1 lakh.
According to Sebi’s 2022-23 Annual Report, in FY 23, private issues made up 98.79% of the debt mobilized in India. Only the remaining 1.21% was raised through publicly issued bonds. This means most of the bond supply is available at ₹1 lakh ticket size.
Therefore, there are very few good public issues in which retail investors can take part meaningfully. Bond market stakeholders should work together to decrease the ticket size and increase retail investors’ participation and secondary market volume.
Benefits of Corporate Bonds
Now, let’s explore the advantages of investing in corporate bonds:
- Regular Income: Corporate bonds provide a steady stream of income through interest payments. This can be especially attractive for retirees or anyone seeking a predictable source of income.
- Diversification: Bonds can diversify your investment portfolio. They typically have a lower risk profile than stocks, making them a valuable addition to your financial strategy.
- Safety: High-quality corporate bonds from reputable companies are considered relatively safe investments, as these companies are less likely to default on debt payments.
- Capital Preservation: Corporate bonds offer a degree of capital preservation. When held until maturity, you can expect your initial investment back.
Disadvantages of Corporate Bonds
Despite their merits, corporate bonds also come with some downsides:
- Risk of Default: While high-quality corporate bonds are relatively safe, there’s always a risk of the issuer defaulting on its payments. It’s crucial to assess the creditworthiness of the issuing company. We have covered the credit rating system of bonds here.
- Interest Rate Risk: The market value of bonds can fluctuate with changes in interest rates. If you need to sell your bond before maturity, you may incur losses if interest rates have risen since your purchase.
- Lack of Liquidity: Some corporate bonds may have low trading volumes, making them less liquid. This can affect your ability to sell them quickly, especially at a favourable price.
- Inflation Risk: Over time, the purchasing power of your interest payments may erode because of inflation. This is something to consider if your investment goals are long-term.
Why should you invest in corporate bonds?
The decision to invest in corporate bonds depends on your financial goals, risk tolerance, and investment horizon. As mentioned above, investments in corporate bonds can provide steady income, portfolio diversification, and capital preservation.
Here are some other scenarios where corporate bonds might be a suitable option:
- Tax Efficiency: Certain bonds offer tax benefits, like tax-free bonds, which can be advantageous for tax-conscious investors.
- Medium-Term Goals: If you have financial objectives within the next 3-5 years, corporate bonds can be a suitable choice because of their relatively lower risk.
- Conservative Risk Profile: If you have a low-risk tolerance and prefer conservative investments, corporate bonds can be an integral part of your portfolio. You can also check out G-Secs, which are relatively safer than corporate bonds.
In a nutshell, corporate bonds offer a compelling investment option for beginners and experienced investors. They provide a balance of regular income and capital preservation, but it’s crucial to do your research and assess the creditworthiness of the issuer.
Whether you’re looking for a stable source of income, diversification, or a low-risk investment, corporate bonds can play a vital role in your financial journey.
Share these insights with your buddies. Until next time!
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