Corporate Bonds - Definition, Types and Features

Corporate bonds are often a popular choice for investors aiming for higher returns without the market volatility.

The Indian corporate bond market offers a wide range of corporate bonds, allowing investors to diversify their portfolios with these fixed-income assets. In this article, we explore corporate bonds, what they are, the different types, and key features. We are also going to talk about how to invest and get better corporate bond yields.

Table of Contents

• What is a Corporate Bond?
• Types of Corporate Bond Funds
  • Fixed-Rate Bonds
  • Floating Rate Bonds
  • Zero-coupon Bonds
  • Convertible Bonds
  • Non-Convertible Bonds
  • Callable Bonds
  • Putable Bonds
  • Investment Grade Bonds
• Features of Corporate Bond Funds
• How Do You Invest in Corporate Bonds in India?
• Corporate Bond Investment: Primary Market vs Secondary Market
• Corporate Bonds vs Stocks
• Risk Factors and Returns
• Conclusion
• FAQs About Corporate Bonds

What is a Corporate Bond?

Corporate bonds are SEBI-regulated debt instruments that corporations issue in the public market. The objective is to raise capital for operations, expansion and growth without reducing the company's shareholding.

Investors can invest in these bonds, and they receive periodic interest over a fixed period of time. The corporation returns the principal invested amount to the investors at the end of the maturity period.

Types of Corporate Bonds

The following are the various types of corporate bond funds:

Corporate Bond Classification Based on Interest Rates

Fixed-Rate Bonds

Bondholders who purchase vanilla bonds, also known as fixed-rate corporate bonds, receive a fixed amount of interest. Upon issuance, the coupon rate is fixed and remains constant for the duration of the corporate bonds.

Floating Rate Bonds

Bondholders of floating-rate bonds receive varying interest payments based on changes in market rates. The existing market interest rates and the company's capacity to pay bondholders a specific interest rate determine the coupon rate.

Zero-coupon Bonds

These bonds are offered at a discounted price but do not pay bondholders regular interest. Repaying the principal at the time of maturity is the only payment made. Bondholders must, however, pay taxes on the interest that has accrued.

Corporate Bond Classification Based on Convertability

Convertible Bonds

These are hybrid bonds with the potential to be converted into equities depending on the bond's underlying asset. Bondholders become shareholders by converting the bonds into equity shares, and the issuer is released from future interest payments.

The conversion happens at a rate pre-determined during issuance or at the prevailing stock rate.

Non-Convertible Bonds

These corporate bonds do not offer the conversion feature to the investors. Companies issue the bonds; investors receive interest, and the principal investment returns at maturity.

Corporate Bond Classification Based on Buy-Back Options

Callable Bonds

Such bonds allow the issuer to buy back the bonds from the investor before their maturity. An initial lock-in period is common in callable bonds. They also tend to offer a higher rate of interest compared to other bonds, as investors have a risk of the issuer calling the bond prematurely.

Putable Bonds

Such bonds give investors the right to sell the bond back to the issuer before maturity. In contrast to callable bonds, putable bonds expose the issuer to increased risk, which typically results in a lower interest rate.

Other Bonds

Investment Grade Bonds

Credit ratings are used to categorise corporate bonds. Corporate bonds classified as investment-grade have credit ratings that are more excellent than BBB- and above (up to AAA), depending on the rating agency's scale. Financially sound corporations issue investment-grade bonds with very little chance of defaulting on payment.

Features of Corporate Bonds

Businesses can raise capital through the sale of corporate bonds for a range of purposes.

The key features of these bonds are listed below:

• Regular Interest Payment: Corporate bonds frequently offer investors a consistent and dependable income stream through periodic fixed-interest payments.
• Tradability: On the secondary market, they are regularly exchanged. This improves liquidity and permits investors to purchase or sell their bond holdings before the bond's maturity date, allowing them to access their investment capital.
• Comparatively Higher Returns: Corporate bond yields are usually higher than government bonds because of the higher credit risk attached to businesses.
• Defined Maturity Period: Each corporate bond has a pre-set maturity period. Investors know the precise date on which the issuer returns the principal amount. This clarity makes investment and financial planning easier.

How Do You Invest in Corporate Bonds in India?

To initiate investment in the best corporate bonds, an investor begins the process by opening a Demat account and providing necessary documents such as identity proof, address proof, and PAN card details.

Let’s understand this with an example:

After opening a Demat account, the investor discovers a reputable pharmaceutical company in India that offers corporate bonds. This company boasts of a robust financial history and a bond rating indicating minimal default risk. The bonds are issued with a face value of ₹1,000 each, featuring a 5% coupon rate and a 5-year maturity period.

Consequently, when investing ₹1 lakh in corporate bonds, the investor orders 100 bonds, amounting to ₹1 lakh (100 bonds x ₹1,000 face value).

Holding these bonds, the investor receives an annual interest income of ₹5,000 (100 bonds x ₹50 interest per bond) for the subsequent five years. These interest payments are credited to the investor's bank account, which is linked to the Demat account.

Upon completing the 5-year maturity period, the investor receives the face value of the bonds

Corporate Bond Investment: Primary Market vs Secondary Market

Corporate bonds are traded in both the primary and secondary markets in India.

• Primary Market: Investors buy bonds directly from the issuing corporation.
• Secondary Market: Investors buy bonds listed on a stock exchange.

Corporate Bonds vs Stocks

The difference between corporate bonds and stocks:

Risk Factors and Returns

Bond issuers could fail on their commitments at any time. With longer maturities, this default risk increases exponentially and is worse for securities with lower ratings.

That said, highly-rated corporate bonds generally carry a lower risk.

Higher yields are typically associated with higher credit risk. Investors should assess both potential returns and the issuer's ability to meet payment obligations before investing.

Conclusion

When considering corporate bonds, investors should thoroughly investigate possible issuers, paying particular attention to their credit ratings and financial soundness to assess default risk. Keep a close eye on the issuer's credit standing and financial stability for the duration of the investment. In the ever-changing world of corporate bond investing in India, a knowledgeable and well-rounded strategy increases the possibility of steady returns. Compare the high yield corporate bonds list, align with your financial goals and risk profile, and invest accordingly.