Investments are not always about equities. Debt instruments are also a part of investing. Being an investor, one should pick such mutual funds which match their risk profile. In this analysis, we discuss Corporate Bonds, a form of debt instrument. Let’s dive in!
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What are Corporate Bonds?
Any company, which is in need of capital, can thus issue corporate bonds. Also, Non-convertible debentures(NCD) is another name for this instrument. Highly-rated companies issue NCD(fixed income instruments) and subsequently give a better interest. Moreover, businesses can expand or fund their daily operations from such capital.
Companies generally have two options- debt and equity instruments. However, most companies prefer going for the debt instruments as it does not directly impact the shareholders. Furthermore, borrowing from a bank can be expensive. Hence, companies go for debt instruments to raise capital.
When you subsequently purchase a bond, the company is borrowing money from you. There is thus an obligation on the company to pay you the principal at the time of maturity. You will also consequently receive interest(coupon payments) on purchasing this bond, usually twice a year.
It is also important to note that the yield (returns) of the corporate bond are inversely related to the bond price. Consequently, if the bond prices increase, owing to heavy demand, the bond yield decreases. Whereas, if the bond prices thus fall, in case of liquidity fears or geopolitical crisis, the bond yields subsequently go up as companies or governments try to attract buyers with better returns.
What Determines the Interest Rate on Corporate Bonds?
The following factors play a key role in determining the interest rate on a corporate bond,
1. Maturity Period: If an investor has to thus wait for a longer period to receive their principal, they will certainly demand higher interest on their money.
2. Credit quality of the bond issuer: A bond is thus a promise that the corporation will repay you the money at fixed maturity date. If the company subsequently goes bankrupt, you might not get your money back. Stronger companies in comparison thus have a good balance sheet and income statement. They will easily secure loans to service these interest payments.
3. Inflation: When inflation is extremely high, bond investors will thus demand a higher yield(interest). This will consequently guard them against losing purchasing power.
4. Macroeconomic factors: If the world is facing a nuclear threat or a nation is on the verge of being invaded, bond prices will collapse. This will thus lead to an increase in the bond yield(as governments or companies will raise the interest to attract people), as investors will withdraw their money for liquidity fears.
5. Price: You might get a subsequently different price if you purchase a bond from the secondary market( from another investor) instead of buying at the time of issuance. Investors in the past have thus bought high-grade bonds at attractive prices during depressions and recessions and consequently benefitted.
Benefits of Corporate Bonds
1. Price of Bonds: Each bond has consequently dynamic pricing. You can subsequently find different prices for the same bond depending on the time of purchase. As an investor, one has to check how it varies from par value. Thus, they will understand the market movement.
2. Par Value of the bond: This value is the amount the company thus pays on bond maturity. In India, it is usually Rs 1000. Consequently, it becomes important to consider it while buying.
3. Current Yield: Annual returns an investor makes from a bond is called current yield. For example, if the coupon rate of a bond with Rs 1,000 par value is 30%, then the company pays Rs 300 as the interest per year.
4. Coupon (interest): Every investor who buys a bond, consequently receives an interest regularly from the issuing company. Also called coupon payment. It is thus a certain percentage of the par value.
5. Yield to Maturity (YTM): It is the total returns an investor will thus achieve, holding the bond till maturity. For example, a Fund Manager will re-invest all the coupon payments he receives from the bond. Consequently re-invested into the bond. The higher the YTM, the higher will be the returns.
6. Tax-efficiency: If you thus hold the bonds for less than 3 years, you will have to pay Short-term capital gains as per your tax slab. Moreover, for bonds held for more than 3 years, 20% tax is levied.
7. Exposure: Sometimes, corporate bonds do invest in government securities. Also, they do so only when no other opportunity exists in the credit space. Sovereign fixed-income assets thus get a 5.22% allocation usually.
How do corporate bonds make returns?
Debt markets deal in corporate bonds. Subsequently, this is just like the stock market. Also, the prices of bonds can rise or fall depending on various factors. For example, if a mutual fund purchases a bond. Its price will subsequently go up in the market. This will thus lead to an enhanced income for the bond over and above the interest it would have earned. Moreover, it can also give a negative return depending on the market scenario.
Types of Corporate Bonds
There are types of bonds in India, namely,
1. Type 1: These types of bonds thus invest predominantly in high-rated companies like PSU's and banks.
2. Type 2: These types of bonds invest in slightly lower-rated companies (AA- and below).
Furthermore, corporate bonds allocate half of their portfolio to AA grade or lower bonds. Thus, there is always a chance of some of the companies defaulting and reducing the overall portfolio returns.
Top Corporate Bonds in India 2021
|L&T Triple Ace Bond Fund||8.25||9.59||8.70||8.45||8.04|
|Axis Corporate Debt Fund||9.21||8.09||—||—||—|
|HDFC Corporate Bond Fund||9.07||9.04||8.81||9.05||9.00|
|ABSL Corporate Bond Fund||9.54||9.07||8.70||9.03||9.20|
|ICICI Prudential Corporate Bond Fund||8.64||8.62||8.35||8.54||—|
|IDFC Corporate Bond Fund||8.94||8.28||8.25||—||—|
High-rated companies thus issue corporate bonds to raise capital for their daily operations or business expansion. Corporate bonds are thus debt instruments. Moreover, they do not impact the shareholders of the company directly. Also, they issue half-yearly interest payments to the buyers. Also called coupon payments. Bond yield(returns) is inversely proportional to the bond price. They thus depend on a lot of factors and should be considered before investing. Consequently, they are a highly attractive investment option for modern-day investors and one of the safest avenues.
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