5 Points to Consider When Buying Corporate Bonds

Bonds or Securities or Debentures are like shares or stocks issued by different companies or Government authorities. These bonds or securities are much safer than stocks, though they yield lesser return. When these shares are issued by corporate houses or any business company they are called bonds and when these are issued by any Government authority they are called securities or government securities. Owing to the higher interest rate of 16%-17% in business loans government or the companies collect their capital to either run their business or expand the business by issuing securities or bonds or non-convertible debenture with a guarantee to repay the amount of the invested money when the security or bond is matured. When these bonds are issued by private companies they are known as corporate bonds. In this column we will discuss the 5 Points to consider when buying Corporate Bonds.

What is Government Securities

Generally, government securities are considered as low risk as government of India backs these securities with its monetary power and with a promise of interest payments usually half yearly. The same mechanism is followed by corporate companies. They also issue bonds or non-convertible debentures to collect money from the market. They usually offer higher coupon rate i.e., the interest received on the principal amount invested than the government bonds.

Usually, government issues these bonds via RBI to meet the budget deficit and carry out the expenses to run the country. There are usually two types of govt. securities namely,

Treasury notes (T-notes) are intermediate-term bonds that mature within two, three, five or 10 years. They provide semi-annual interest payments at fixed coupon or interest rates.

Treasury bonds (T-Bonds) are long-term bonds maturing between 10 and 30 years. T-Bonds provide semi-annual interest payments.

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Why Government issues Bonds or securities

Government securities or bonds invest in savings bonds issued or guaranteed by Government of India. There are many types of securities such as treasury bonds and bills as well as mortgages and other various asset-backed securities. Government of India promises to give periodic interest on all these bonds. In fact Government or any Government authority such as RBI, NABARD and NHAI issues securities to raise money from the market for infrastructure development or any other activities like expansion of business or run the day to day business at the shortfall of money.

If Govt. or any Government authority or any private concern receives loan from a bank or any other financial institution the interest rate is higher there. It is about 17%-18% per year. So, to meet the financial needs government or any authority withdraws money from market by issuing shares popularly known as securities or bonds. Government pays very little interest rate of 7%-8% compounded semi-annually to the security holder. Corporate bonds yield greater return and of higher risky than government securities. Corporate bonds offer 10%-15% return to bond holders. The interest gained from bonds and securities is taxable. Like stock market the prices of securities or bonds may go up and down time to time. A change in rating issued by various rating agencies may influence the prices of bonds towards up or down.

Who can invest

Any citizen of India is eligible to invest in securities or bonds. Usually these bonds offer higher interest rate than the FDs in banks or post offices. This is the best option for those who want secured and fixed income and higher return than Bank FDs.

How they work

Corporate Bonds or securities work on the same principle as the stocks work. There is a debt market for debt securities and bonds like stock market. The prices of the securities or bonds go up and down due to supply and demand. Interest rate of banks affect widely on bonds and securities. If the interest rate of banks increases then the demand of the bonds or securities decreases. It is because if the bank gives satisfactory return why people will invest in debt securities which carry risk. In our country, India, people consider banks and post offices to be the safest place to park their money. And if the interest rate decreases then the investors head to debt securities in search of better returns than FDs. The demand of bonds increases and gives better returns to holders owing to increase in demand for bonds or securities.

Here are 5 points to consider when buying Corporate Bonds

Creditworthiness

You need to consider the risk of default in payment by the bond issuing authority.  The default could be in the form of untimely payment of coupons/interest rate or non-payment of the principal at the time of maturity. The chances of a default can be assessed with the rating a bond or security gains from various agencies. The higher rating indicates that the bond or security authority is able to pay the money invested by lowering the chances of default.

Rating

You need to check out the rating of the bond marked by rating agencies like CRISIL, CARE etc. If the bond has AAA rating then it is considered the safest bet. But Ratings do not account for all the risks associated with bonds. New risks can arise after you have purchased the bond. For example, if an issuer decides to go for acquisition or any other restructuring, the debt burden on the issuer will increase. This will affect the issuer’s ability to service the existing bond liability. This will increase the risk profile of the bond that you are holding leading to reduce the price of the bond.

Expenses & Exit Load

You need to check out your investment horizon before investing in corporate bonds. You should invest in such bonds or securities which can meet your investment horizon. In accordance with your time horizon, you should also see the bond’s maturity period.

Fund manager Risk

There is a misconception among the investors that fund managers have no role to play in bonds, especially in corporate bonds as of equity mutual fund. But fund manager is equally important as the rating of a bond. If the fund manager invests the money of the retail investors in highly credit risk instruments in search of better returns and if the rating agencies downgrade the bond, it adversely affects the bond yield in the long term. Again, when the fund manager puts money in highly credit Risk Companies and these companies make default to pay the coupon rate it can cause a setback for investors.

Tax Efficiency

If you invest in bonds for less than 3 years then you need to pay short term capital gains tax on interest incurred. But if you stay invested for more than 3 year you will be charged long term capital gains under section 112 of the Income Tax Act, 1961.

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Finally, an investor should stick to such corporate bonds which are highly rated and possess strong fundamentals. New investors are advised to make investment in corporate bonds having lower credit risk and of course for long term horizon.

If you have any question regarding the corporate bonds then make a comment and if you have found this post helpful please share with your loved ones.