Corporate Bonds vs. Government Bonds – Key Differences

Corporate bonds are issued by private or public companies to raise funds, offering attractive interest rates and carrying higher risks than their Government counterparts. The latter are issued to raise funds for public infrastructure projects with comparatively lower interest rates and risks alike. Let us look at the Corporate bonds vs. Government bonds debate in more detail below. 

What Are Corporate Bonds?

Corporate bonds are issued to raise money for future expansion, new projects, debt consolidation, and various other purposes. They are not issued by the Government, and that is the key difference between Government and Corporate bonds. As an investor, you will lend money to the company raising the bond, and it will offer interest/coupon payments while returning the principal at the time of maturity. The bonds are classified based on their credit quality. 

Companies with solid financials have investment-grade bonds that come with decent returns and comparatively lower risks. On the other hand, junk or high-yield bonds are issued by entities with poor credit ratings. However, they may offer potentially higher returns to offset sizable risks. Now, while corporate bonds may often have higher returns than their Government-issued counterparts, they may be riskier due to possible defaults. You should thus consider the company’s financial position and credit ratings carefully before going ahead with your investment. 

Know more About : What Are Corporate Bonds?

What Are Government Bonds?

Government bonds are issued to raise funds for various public projects and infrastructure development, along with managing internal debt. Thus, by purchasing the same, you will lend money to the Government in return for a pre-fixed rate of interest that is payable at intervals (coupons). The principal amount will also be returned at the time of maturity. 

They are minimal-risk investments and hence come with comparatively lower interest rates than corporate bonds at times. Multiple kinds of bonds are classified and issued in this category in India, based on the G-Sec system. 

Key Differences Between Corporate & Government Bonds

Here is a closer look at the major difference between corporate and Government bonds for your understanding. 

Types of Corporate Bonds

The main types of corporate bonds include: 

• Investment-Grade Bonds
  They are issued by large and reputed companies with high credit ratings (BBB and higher) and relatively lower returns. Yet, they are safer investment options than many of their counterparts. 
• High-Yield or Junk Bonds
  They are issued by companies which have lower credit ratings (BB and below), while carrying higher risks and chances of defaults. 
• Callable Bonds
  These are bonds that the issuer may redeem before maturity. They are sold at a premium rate while paying higher yields to offset the potential risk of being called.
• Convertible Bonds
  They may be transformed into company stocks at a pre-fixed price, while offering lower yields overall. However, the returns can be higher in case the share values go up in the future. 

Types of Government Bonds 

There are various kinds of Government bonds available for investors, including the following: 

• Treasury Bonds
  T-bonds are usually issued for longer durations with a maturity period ranging between 10-30 years. They are secure investments backed by the Government and pay interest regularly at intervals. 
• Treasury Notes
  T-notes are bonds which have a medium term and maturity periods between 2-10 years. They pay out interest regularly, making them less risky than T-bonds. 
• Sovereign Gold Bonds
  SGBs are bonds that are linked to the gold rates in India and may offer fixed interest rates. 
• Treasury Bills
  T-bills are bonds given for a short period (maturity is usually less than one year) and they do not come with interest. However, they are available for purchase at a discounted rate, which makes it possible to earn a profit when the bond finally matures. 
• Inflation-protected Securities
  They are bonds whose returns will go up with inflation. In such a scenario, the principal amount increases, helping investors retain overall purchasing power. 

Pros & Cons

Let us now look at the pros and cons of corporate bonds and Government bonds in more detail. 

Pros of Corporate Bonds

• Higher returns than Government bonds 
• Fixed income bonds may pay regular interest 
• You will get access to a large variety of options based on your risk level and investment goals
• Corporate bonds are issued with different maturities and credit ratings, enabling you to invest based on your risk and return goals. 

Cons of Corporate Bonds

• There are risks of defaults by issuers 
• Some corporate bonds may be hard to sell quickly without incurring losses 
• Bond prices and demand may fluctuate based on market conditions and other economic aspects 
• Callable bonds always have risks of issuers redeeming them early, thereby leading to a yield-to-maturity impact. 

Pros of Government Bonds

• They are backed and guaranteed by the Government, thereby ensuring negligible investment risks
• They offer stable interest earnings and are highly liquid in the secondary market 
• They can enable better risk management and balance the portfolio 
• Many bonds are tax-free as well 

Cons of Government Bonds

• The returns may be lower than corporate bonds  
• Interest rates may not always match up to inflation 
• Demand may negatively impact the liquidity levels of some bonds 
• There is lower growth potential in comparison to stocks 
• Interest earned/accrued on many bonds is taxable 

Which One Should You Choose?

So, coming back to the corporate bonds and government bonds question- which one should you choose? Let’s take a look at the three probable choices in this case. 

• If you’re risk-averse - In case you want only the lowest/negligible level of risk and more stability, then Government bonds are clearly the best solutions for your portfolio. 
• If you expect higher returns and have moderate risk-appetite - Corporate bonds may be better choices if you’re okay with moderate to high risks and want to earn more returns. 
• If you wish to diversify your portfolio - To balance and diversify your portfolio with a mix of high and low-risk investments, you can choose both corporate and Government bonds. This will help you strike the right balance between risks and returns. 

Conclusion

Both Government and corporate bonds have their own advantages and limitations. It’s up to you to choose the best options, depending on your risk appetite and future investment goals.