Corporate bonds in India represent a compelling facet of the investment landscape, offering a blend of potential rewards and manageable risks. Issued by companies in both the private sector and public sector undertakings (PSUs), these bonds diversify an investor’s portfolio and often provide higher returns compared to traditional fixed-income assets. This guide aims to simplify the complexities of corporate bonds, shedding light on their workings, types, advantages, risks, and tax implications.
What Are Corporate Bonds?
Corporate bonds are debt securities issued by corporations to raise capital. Unlike government-issued bonds, corporate bonds are associated with higher risk but also promise higher returns. They are crucial financial instruments for companies to secure funds without relinquishing ownership control.
How Do Corporate Bonds Work?
When investors buy corporate bonds, they lend money to the issuing corporation. In return, they receive periodic interest payments, known as coupons, based on the bond’s coupon rate. Upon maturity, the investors get their principal amount back. If sold before maturity, the bond’s market price can lead to capital gains or losses influenced by prevailing interest rates and market conditions.
Types of Corporate Bonds in India
Corporate bonds in India can be categorised based on various factors such as the type of issuer, security, seniority, credit rating, interest rate, maturity, and listing status.
Based on the Issuer
- Private Sector Bonds – Issued by private companies. Example – Tata Motors Finance Solutions.
- PSU Bonds – Issued by public sector undertakings. Example – Power Finance Corporation.
Based on Security
- Secured Bonds – Backed by collateral, providing extra security to bondholders. In case of default, bondholders can claim the collateral.
- Unsecured Bonds – Not backed by collateral, considered riskier, especially when issued by private companies.
Based on Seniority
- Senior Secured Bonds – Have the highest priority in repayment during bankruptcy.
- Senior Unsecured Bonds – Next in line after senior secured bonds.
- Subordinated Bonds – Lower priority, divided into tiers (e.g., Tier 1, Tier 2).
Based on Credit Rating
- AAA Rated Bonds – Highest safety, lower interest rates.
- AA Rated Bonds – High safety, slightly higher interest rates.
- A Rated Bonds – Moderate safety, higher interest rates.
- BBB Rated Bonds and Lower – Higher risk, highest interest rates, not recommended for conservative investors.
Based on Interest Rate
- Fixed Interest Rate Bonds – Pay a consistent interest rate throughout their tenure.
- Floating Interest Rate Bonds – Interest rate varies based on a benchmark rate (e.g., GOI FRB 2033).
Based on Maturity (Term)
- Ultra-Short Term Bonds – Maturity of less than one year.
- Short-Term Bonds – Maturity between 1 to 3 years.
- Medium-Term Bonds – Maturity between 3 to 5 years.
- Long-Term Bonds – Maturity of 5 years or more.
- Perpetual Bonds – Pay interest indefinitely, principal never returned, but may include a call option for the issuer.
Based on Listing
- Listed Bonds – Traded on stock exchanges like NSE or BSE.
- Unlisted Bonds – Not traded on stock exchanges, traded over-the-counter (OTC).
Are Corporate Bonds a Good Buy?
Yes, corporate bonds are a viable option for investors willing to accept some risk within the fixed-income asset class. They generally offer higher returns than government bonds but with increased risk. Many investors prefer corporate bonds over fixed deposits for the debt allocation in their portfolios due to the higher yields.
Eligibility of NRIs
NRIs can invest in corporate bonds issued by PSUs but are restricted from investing in those issued by private sector companies. This provides a relatively safe investment avenue for NRIs, given the government backing of PSUs.
High Yield Corporate Bonds
High-yield corporate bonds often rated A or lower, offer higher interest rates to attract investors who are willing to take on more risk. These bonds compensate investors for the higher default risk associated with lower-rated issuers.
Taxation of Corporate Bonds
- Interest Income – Interest earned from corporate bonds is added to annual income and taxed as per the investor’s marginal income tax slab rate.
- Capital Gains –
- Listed Bonds – Long-term capital gains (held for more than 36 months) are taxed at 10%, while short-term gains (held for less than 36 months) are taxed at the investor’s marginal income tax rate.
- Unlisted Bonds – Long-term capital gains (held for more than 12 months) are taxed at 20% with indexation benefits, and short-term gains (held for less than 12 months) are taxed at the investor’s marginal income tax rate.
Risks of Investing in Corporate Bonds
- Credit Default Risk – The risk that the issuer may fail to make interest payments or repay the principal.
- Interest Rate Risk – The risk that changes in interest rates will affect the bond’s market value.
- Liquidity Risk – The risk that the bond may not be easily sold in the secondary market.
- Reinvestment Risk – The risk that the proceeds from a bond may be reinvested at a lower interest rate.
Corporate Bonds vs. Corporate Bond Mutual Funds
The primary difference between corporate bonds and corporate bond mutual funds lies in diversification. Investing in a single corporate bond exposes you to the specific risks of that issuer. In contrast, corporate bond mutual funds spread the investment across a portfolio of corporate bonds, reducing individual issuer risk and offering diversified exposure.
Conclusion
Corporate bonds offer a promising investment option for those looking to diversify their portfolio and achieve higher returns compared to traditional fixed-income assets. While they come with inherent risks, careful selection based on credit ratings and issuer reputation can mitigate these risks. Investors should consider their risk tolerance, investment horizon, and financial goals before investing in corporate bonds.
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