Corporate Bonds

What are Corporate Bonds in India?

Corporate Bonds in India are issued by public & private sector companies to raise capital from investors. These bonds are debt instruments wherein the issuing company makes periodic interest payments to its investors and returns the principal amount on their maturity dates. These bonds serve as an important source of funding for companies looking to finance expansion, manage operations or refinance existing debt.

Corporate Bond Interest Rates

The corporate bond interest rate refers to the coupon rate paid by companies periodically to their investors in exchange for lending money. It is fixed on the bond's face value at the time of bond issuance and remains unchanged until maturity.

Currently, you can earn the highest fixed returns of up to 13.25% on corporate bonds by investing in AAA-BBB bonds online through Tax Intelligence with a minimum amount of Rs 1,000.

For instance, if a bond offers 10% coupon rate on the face value of Rs 1,000, it pays Rs 100 interest annually, semi-annually, or monthly, depending on the type of bond. While the coupon rate is calculated on the bond’s face value, the yield represents the true return a bondholder earns based on the price paid in the market. If the bond is bought at a premium, the yield falls; if it is purchased at a discount, the yield rises.

Factors Affecting Corporate Bond Interest Rates

Corporate bond interest rates are primarily dependent on the issuer's credit rating. Bonds issued by governments or government-backed PSUs or companies with higher credit ratings usually offer lower coupon rates as they are considered less risky. Therefore, also categorised as low risk bonds. On the other hand, bonds issued by companies with poor credit ratings usually offer higher coupon or interest rates to compensate for the higher risk involved. These bonds are referred to as high yield bonds.

How do Corporate Bonds Work in India?

Companies issue bonds to raise finances for their expansion, new projects, or other financial requirements. Investors who purchase these bonds become creditors of the company. Here’s how corporate bonds work:-

• An investor lends a fixed amount, i.e., the principal, to the bond issuing company. The issuer, in return, repays this principal on a predetermined maturity date.
• The issuing company makes periodic interest payments to the bondholders.
• Investors can choose to hold bonds until maturity and receive the full face value. They also have the option to sell their bonds before the maturity date in the secondary market. The selling price may be higher or lower than the purchase price, depending on prevailing market interest rates.
• Note that while corporate bonds act as an IOU for the bond issuing company, its bondholders do not have an ownership interest in the company like its shareholders.

Corporate Bond Ratings

SEBI-recognised credit rating agencies like CRISIL, ICRA, CARE, etc, assess issuer’s financial health and accordingly, assign credit ratings to their bonds. These ratings indicate the likelihood of the timely servicing of the bonds’ interest and principal repayment. As per the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021, a bond issuer must obtain at least one credit rating from a registered credit rating agency and disclose it in their offer document.

The credit rating scales used by the credit rating agencies range from high (AAA) to low (D) with the higher credit ratings indicating higher chances of receiving the face value amount and interest income on time.

Note: Ratings from AA to C may include a “+” or “–” sign depicting the bond issuer’s relative position within the category. For example, AA+ is stronger than AA, and AA– is slightly weaker than AA.

Why Invest in Corporate Bonds?

• Corporate bonds provide a fixed income through periodic coupon payments, ensuring a steady cash flow for investors.
• Corporate bonds generate higher returns than bank FDs, small savings schemes and government bonds, providing an alternative for fixed income investors to earn higher interest income.
• Returns generated by corporate bonds are less correlated to stock returns, which helps in diversification of their investment portfolios and reduction in their volatility.
• Being debt instruments, bondholders receive higher repayment priority over shareholders in the event of the liquidation of the bond issuing company.
• While corporate bonds generate lower returns than stocks, they also carry lower risk. This makes corporate bonds an ideal investment instrument for those having lower risk appetite.
• The pre-determined dates of coupon (interest) and maturity payments in corporate bonds can help investors to align their cash inflows from bonds with their financial goals and provide more clarity to their financial planning objectives.
• Listed corporate bonds can be sold in secondary markets before their maturity dates.
• Factors like falling interest rates or credit rating upgrades can lead bond prices to appreciate, allowing their investors to book capital gains by selling those bonds before their maturity dates.
• Negative investor sentiment for a bond issuing company or its sector/segment can lead to a fall in its bond prices. Investors having moderate or higher risk appetite can exploit such opportunities to earn higher yields.

Corporate Bonds vs Government Bonds

Risks Involved in Investing in Corporate Bonds

Although corporate bonds are often seen as safer than equities, they come with their own set of risks that investors must understand and manage wisely:

Credit Risk: Credit risk refers to the situation when the issuer may fail to make timely interest payments or repay the principal. To manage this risk, investors should evaluate the issuer’s financial strength and credit rating. Corporate bonds having higher credit rating have lower credit risk.

Prepayment Risk: Some corporate bonds allow issuers to repay the debt before their maturity dates, especially during a falling interest rate regime. While this benefits the bond issuer, it can leave their investors to invest the bond maturity proceeds in instruments offering lower returns. To guard against this, investors should carefully check for callability or buyback related clauses before investing.

Interest Rate Risk: Bond prices move inversely to interest rates - when rates rise, the market price of the bond falls and vice versa. This risk is higher in corporate bonds having longer residual maturity. Investors seeking to avoid this risk should aim at staying invested in their corporate bonds till their maturity dates.

Liquidity Risk: If a bond is not actively traded, it might be difficult to sell it at a fair price before its maturity date. Thus, a lack of liquidity can lead to losses or delays in converting the investment to cash. Choosing listed bonds having sizeable trading volume can help reduce this risk for the investor.

Classification of Corporate Bonds

Corporate bonds can be categorised on the basis of their periodicity of interest payments, type of interest rate, collateral attached, convertibility and buy-back features.

1. Corporate Bonds Classification in terms of Interest Rate Type

Fixed Rate Bonds: A fixed rate bond offers periodic interest payments as per the interest rate fixed at the time of bond issuance. This interest payment, often called a coupon payment, is calculated as a percentage of the face value of the bond. The interest rate is called the coupon rate.

Floating Rate Bonds: A floating rate bond has its interest rate linked to a benchmark like government bond yields or the Mumbai Interbank Offered Rate (MIBOR), etc. As the benchmark rate fluctuates, the interest rate of the bond also fluctuates accordingly. Due to this dependency on the movement of the benchmark rate, the income certainty of the floating-rate bonds is much lower.

Zero Coupon Bonds: Zero coupon bonds do not provide periodic interest payments. These bonds are issued at a discount on the bond’s face value. The bondholder receives the face value of his investment on maturity. The investor purchasing a zero coupon bond profits from the difference between the purchase price and the face value of the bond.

2. Corporate Bonds Classification in terms of the Periodicity of Interest Payments

Cumulative Bonds: In the case of cumulative bonds, their issuers pay back the interest income, accrued over the bond tenure, on their maturity dates. These bonds are suitable for investors who prefer growth over regular income.

Non-Cumulative Bonds: In the case of non-cumulative bonds, the accrued interest income is paid out at regular intervals, viz, monthly, quarterly, semi-annually, or annually, depending on the interest payment frequency set at the time of bond issuance. These bonds are suitable for investors requiring a steady income stream.

3. Corporate Bonds Classification in terms of Collateral

Secured Bonds: Secured bonds are backed by specific collateral pledged by the issuing company—such as real estate, machinery, or other tangible assets. In the event of a default or winding up of the bond issuers, the pledged assets of secured bonds can be sold to repay their investors. This added layer of security makes secured bonds less risky compared to unsecured bonds.

Secured bonds can be further classified into senior and junior (subordinated) bonds. Investors holding senior secured bonds receive higher priority in terms of claim on the issuing company’s assets during liquidation or defaults.

Unsecured Bonds: Unsecured bonds are not backed by any specific collateral of the bond issuing company.

4. Corporate Bonds Classification in terms of Convertibility

Convertible Bonds: Convertible Bonds can be converted into equity shares of the issuing company. The conversion can either take at a pre-determined price set at the time of the bond issuance or at the prevailing stock price at the time of conversion. As convertible bonds allow their investors to exercise the option of converting them into equity shares, the coupon rates offered on convertible corporate bonds are usually lower than their non-convertible counterparts.

Some companies issue corporate bonds that are to be compulsorily converted to equities on a preset date. Such bonds are known as compulsorily convertible bonds.

Non-Convertible Bonds: Corporate bonds that do not allow their investors the option of conversion to equities of the issuing company are known as non-convertible bonds.

5. Classification in terms of Buy-Back Options

Callable Corporate Bonds: Callable bonds allow their corporate issuers the right to exercise buybacks from their existing bond holders before their maturity dates.

Puttable Corporate Bonds: Puttable bonds allow their investors to sell back their bonds before their maturity dates on pre-determined dates.

How to Invest in Corporate Bonds?

The company can issue corporate bonds to raise capital through two primary methods: a public issue or a private placement.

1. Investing through Public Issue vs. Private Placement

In a public issue, the company invites the general public to subscribe to its bonds. Before doing so, the company must issue a prospectus stating details about the company and bonds to be issued – its face value, coupon rates, nature of the instrument (secured or unsecured), maturity dates/tenor, seniority (i.e. senior or sub-ordinate bonds), coupon payment frequency, etc. Once the public issue is completed, the bonds are listed on stock exchanges like NSE or BSE—making them listed bonds.

On the other hand, private placements of bonds in India are usually offered to a select group of persons (not exceeding 200 as per Companies Act, 2013) in addition to qualified institutional buyers.

2. Investing in Corporate Bonds through Primary Market vs Secondary Market 

Investors can invest in listed corporate bonds primarily through two routes:

• Primary Market: This is where an investor can buy bonds directly from the issuer during the initial offer period. The price of the bond can be set at par (i.e. at face value of the bond) or at a discount/premium.
• Secondary Market: Once a bond is listed on a stock exchange, investors can buy that bond directly from its existing investors through the stock exchange(s) at its market price.

Retail investors can purchase and sell corporate bonds through conventional stockbrokers and OBPP (Online Bond Platform Providers).

Who Should Invest in Corporate Bonds?

Corporate Bonds are ideal for:-

• Investors seeking an investment instrument generating fixed interest income at predetermined dates.
• Conservative investors seeking higher returns than bank fixed deposits and small savings schemes but are not comfortable with the high volatility of equities.
• Investors who currently have equity-heavy portfolios and seek to add fixed income instruments make their portfolio more balanced and thereby, reduce their portfolio volatility.
• Investors seeking to generate capital gains due to falling interest rates in the economy or due to the potential rating upgrades of specific corporate bonds.

Things to Consider before Investing in Corporate Bonds

1. Understand Whether the Bond Is Secured or Unsecured

Before investing, determine whether the bond is secured (backed by the issuer’s collateral) or unsecured (not backed by collateral). In the case of secured bonds, the collateral can be liquidated to repay investors in case of a default. This provides higher capital protection to secured bond investors. Within the secured bonds category, senior secured bonds have repayment priority over subordinated bonds in case of default. As unsecured bonds are not backed by collateral, they carry a higher risk for their investors. This leads companies to pay higher yields on its unsecured bonds to compensate for the higher risk involved.

2. Liquidity in the Secondary Market

Check how easily the bond can be traded in the secondary market. If you plan to sell the bond before its maturity date or at least want to keep this option open, ensure that the bond is sufficiently liquid in the secondary market with active buyers and sellers. Investing in an illiquid bond may not allow you to sell the bond due to limited market participants.

3. Credit Rating & Default Risk

Credit ratings (e.g., AAA, AA, A) from rating agencies like ICRA, CRISIL, CARE, etc reflect the issuer’s creditworthiness and default risk. Higher-rated bonds, such as AAA bonds, usually have lower chances of default and thus, offer lower yields due to the lower risk for the investors. Conversely, as lower-rated bonds carry higher credit risk, their issuers offer higher yields to compensate their investors. Thus, before investing in any bond, compare the bond credit rating, your own risk appetite and your return expectations and then invest accordingly. Usually, government-backed entities such as NHAI Bonds, REC Bonds carry the highest credit rating of AAA.

4. Call Option (Callability Clause)

Another important factor to check is whether a bond has a callability clause for its issuer. A bond having a callability clause allows its issuer to redeem it before its maturity date. Companies usually exercise this clause when the market interest rates fall so that the issuer can reduce its interest cost by issuing fresh bonds at a lower coupon rate. However, exercise of this option increases the reinvestment risk for the investor, as the amount received when the bond is called may need to be reinvested at lower yields during the falling interest rate regime.

5. Issuer's Financial Health

Investors can analyze the financial health of the company by checking its business model, financial statements, annual reports, and various financial ratios like interest coverage ratio, debt to equity ratio, etc. Additionally, assess whether the company has a history of defaults, has previously rolled over its debt, violated loan agreements, or is/was involved in any significant legal disputes. Investors should also check the maturity pattern of the existing loans of the bond issuing company and whether a significant amount of debt would mature soon.

Tax Implications of Corporate Bonds

Bond interest income is fully taxable as per the individual’s income tax slab. However, interest income of tax free bonds issued by REC, PFC, etc are tax free. Thus, investors should calculate the post-tax yield to understand the actual return on their investment and for comparing them with the returns offered by instruments belonging to other asset classes. Additionally, capital gains (if the bond is sold before its maturity at a higher price) generated on selling a bond may be taxed as short-term or long-term capital gains depending on the holding period.

Short term capital gains (STCG), i.e., gains booked within 12 months of the bond purchase, from listed or unlisted bonds are taxed at the slab rate of the investors. Long term capital gains (LTCG), gains booked after 1 year of bond purchase, from listed bonds are taxed at 12.5%. Investors should consider the implications of tax on bonds while calculating the overall returns from their investments