Understanding corporate bonds
make a consistent living while preserving the value of your investment is called a corporate bond.
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A corporation issues a corporate bond to aid in market capitalization. When investors purchase a corporate bond, they effectively give the company money in exchange for interest payments made according to a predetermined timetable.
Because it is less expensive than obtaining money through stock investments and doesn’t dilute the company’s ownership, companies may prefer to raise money through debt financing techniques like bonds.
An investor can generate recurring cashflows by purchasing corporate bonds at a predetermined frequency (agreed through a repayment schedule).
The Company is referred to as the Issuer of the Bond or the Borrower if it is obtaining cash through a corporate bond. The Bond Subscriber is the Investor who is providing the capital.
Additionally, the government can raise funds by issuing bonds, which are known as government bonds.
It is crucial to remember that Corporate Bonds can differ greatly depending on the underlying terms, which highlight the bond’s qualities. The underlying risk and return connected with the Issue are also described in these terms and conditions. Therefore, before investing, it’s crucial to grasp the exact terms.
Some Key Terms
Face Value: The amount that the bond’s investor will get at maturation is referred to as the bond’s Face Value. It can be compared to the loan principle that you have given the borrower.
Coupon: The bond’s annual interest rate is expressed as a coupon. This would establish how frequently interest will be paid to investors.
Yield to Maturity (YTM): It describes how much a bond will return if held to maturity. The yield-to-maturity (YTM) is 15%, for instance, and if you invested 100 rupees in a bond and earned 115 rupees when it matured after a year.
Current yield: It is calculated by dividing the interest a bond generates by its price (investment amount). In the case of equities, it might be contrasted to the dividend yield.
Characteristics of a Bond
It’s critical to comprehend the traits of a given bond issue while evaluating it. Here are a few things to consider.
|Coupon||Monthly, Quarterly, Annual, Zero Coupon (investment amount only paid on maturity)|
|Repayment||Single repayment at maturity (Bullet repayment) Varying repayment amount (Structured repayment)|
|Rated/Unrated||Rating agencies evaluate the creditworthiness (ability to repay interest or principal) of the issuer based on various financial and non-financial parameters and management. Based on the evaluation, certain ratings may range from D (Default, highest risk) to AAA (low risk). Government bonds carry the lowest credit risk and is considered almost risk-free.|
|Listed/Unlisted||Listed bonds can be traded in the secondary market like equities and therefore are more liquid than Unlisted bonds.|
|Secured/Unsecured||Issue backed by tangible assets are secured bonds and, therefore, less risky than unsecured bonds.|
|Convertible bonds: Gets mandatorily converted into equity at maturity at a predefined ratio/formula.|
Non-convertible bonds: Cannot be converted into equity at any point in time
Optionally convertible bonds: May be converted into equity at the option of debenture holders/Issuer, as the case may be
Understanding Risks Associated with Bonds
Corporate bonds carry some risks, just like any other debt product. These hazards might range from minor to quite high, depending on the Bond and its features. So, before investing in this asset class, it is crucial to understand and evaluate the risks involved.
|Key risk factors||Definition||Mitigating Risks|
|Credit/Default risk||This depends on the borrower’s creditworthiness and the ability to pay regular interest and repay the investment amount on maturity.||Typically, a rating agency would review the Issuer of the Bond for its creditworthiness and provide a rating which forms a good indicator of the amount of credit risk.|
The rating may range from Below BBB, which has the highest risk, to AAA rated (triple-A rated), which has the lowest risk.
|Maturity/Duration risk||This is the risk associated with the amount of time/duration an investor’s money will be invested.||Assets with a lower maturity period (3 to 24 months) have a lower risk compared to assets with maturity periods > 24 months.|
|Liquidity risk||The ease with which investors may sell the investment and recover the invested amount||This is a subjective risk depending on how important the liquidity of funds is to an investor. Listed Bonds can, by definition, be traded in the secondary market, whereas it is extremely difficult to find purchasers for unlisted bonds in the secondary market therefore means that the investment amount is locked in till the maturity period.|
|Structure risk||The Structure of a bond helps identify what recourse an investor has in case of a default. A bond that is secured by an asset, for example, is lower risk.||A secured bond represents a lower risk compared to an unsecured bond.|
However, if the risks are understood and assessed, a Corporate Bond can form a powerful asset class that provides great returns.
Why should you invest in high-quality Corporate Bonds
|Provides a Fixed Income Stream||This asset class allows investors to earn regular income through interest payments.|
|Helps in Capital Preservation||A strong corporate credit profile ensures investment value is preserved, i.e. Issuer will repay the principal value of the loan as per the agreed schedule.|
|Secured||Issue backed by tangible assets guarantees from the promoters of the Issuer to repay the loan|
|High return/Low risk||High return relative to risk associated with the underlying security (real estate project, auto, capital goods, gold, etc.)|
|Portfolio Diversification||Adding this asset to your portfolio allows you to diversify across asset classes (debt, equity, etc.), reducing your overall investment portfolio risk.|
|Financial Planning||Due to their nature of being fixed tenure, Corporate Bonds provide certain predictability of returns. This can help investors plan for milestones and financial goals while investing their money in a high-yield instrument.|
Also Read: The Benefits of investing in Bonds!