Investor's Guide to the Corporate Bond Market

The corporate bond market in India offers an alternative to bank fixed deposits as a fixed-income investment option. Like equities, SEBI regulates corporate bonds, which play a crucial role in providing companies with finance and are also attractive investment options for investors.

Let's examine the process of buying corporate bonds, including the related pros and cons, and the key factors to consider before investing.

What Are Corporate Bonds?

Corporate Bonds are debt instruments issued by companies to collect funds from investors, and the companies pay interest (the coupon) at set and predefined times. The principal value is returned to investors at maturity.

For example, you invest ₹1 lakh in a bond with a 5-year maturity at a 10% coupon rate. You would receive ₹10,000 per year for five years, and then, upon maturity, the ₹1 lakh principal is repaid.

According to Section 2(30) of the Companies Act in India, “corporate bonds” and debentures are usually interchangeable words.

Who Can Issue Corporate Bonds in India?

The following entities may issue corporate bonds for investors in India: 

• Public and private companies incorporated in India.
• Multinational subsidiaries incorporated in India.
• Statutory corporations like LIC.

Note: Foreign companies incorporated outside India are not permitted to issue bonds in India.

Benefits of Investing in Corporate Bonds

Here are some of the key benefits of investing in corporate bonds. 

• Higher interest rates than FDs or postal schemes.
• Fixed periodic income (monthly/quarterly/annually).
• Capital appreciation potential is if the bond is traded at a price above its face value.
• Secondary market liquidity for listed bonds.
• In the case of company liquidation, the risk hierarchy favours bondholders over shareholders.

Corporate Bonds vs Equity Shares vs Fixed Deposits

Let us examine a comparison of corporate bonds, FDs, and equity shares in terms of their investment potential and other key aspects. 

Table 1: Corporate Bonds vs Equity Shares

Table 2: Corporate Bonds vs Bank Fixed Deposits

Also Read: Difference between Corporate Bonds and Government Bonds

Types of Corporate Bonds

Here are the major types of corporate bonds that you can consider and their key differences. 

Secured and Unsecured Bonds

• Secured Bonds: Backed by company assets. Higher safety, lower returns.
• Unsecured Bonds: Not backed by assets. Higher risk, higher returns.

Convertible and Non-Convertible

• Convertible Bonds: Can be converted into equity. Lower interest, potential for capital gain.
• Non-convertible Bonds: Pure debt; cannot be converted. Offers higher interest.

Cumulative and Non-Cumulative

• Cumulative Bonds: Unpaid interest accrues and is paid later.
• Non-cumulative Bonds: Missed interest is forfeited if not paid on time.

Callable and Puttable Bonds

• Callable Bonds: The issuer can redeem them before maturity. Offers higher interest due to reinvestment risk.
• Puttable Bonds: The Investor can sell back to the issuer early. Lower interest, but added flexibility.

How to Invest in Corporate Bonds

The investment avenues for corporate bonds for investors are: 

• Public Issues: Bonds offered to the general public through a prospectus.
• Private Placements: Offered to institutional investors; less accessible to retail investors.
• Primary Market: Buying directly from the issuer during a public offering.
• Secondary Market: Buying/selling listed bonds on NSE/BSE.

Listed bonds provide better liquidity and transparency.

Important Bond Features to Evaluate

Now that you know how to invest in corporate bonds, here are some key features that you should examine before making a decision. 

• Interest Rate Type: The interest rates may be fixed for the entire duration or floating, i.e., they may change periodically. 
• Payment Frequency: The payment frequency may be monthly, quarterly, semi-annually, or annually, depending on the bond's terms. You should select the frequency that best suits your specific financial needs. 
• Maturity Date: The date of maturity is important, since it gives you an idea of the timeline for repayment or the duration of the bond. 
• Security Type: There are secured bonds that are backed by underlying collateral or assets of the issuer. Unsecured bonds are also present, i.e., those depending only on the creditworthiness of the issuer. In this case, you should evaluate the credit ratings of bonds (they indicate creditworthiness) before you make your choice. 
• Embedded Options: These bonds give issuers or bondholders the right to take certain future actions. Callable bonds are securities where the issuer has the right to redeem the bond at a specified price before maturity, typically when interest rates decline. Putable bonds give holders the right to sell the bond back to the issuer at a particular price before maturity. This typically occurs when interest rates rise. Convertible bonds are those in which bondholders have the option to convert them into shares of the issuer's common stock. 

Risk Factors in Corporate Bond Investment

Here are the potential risk factors to watch out for: 

• Credit Risk: This refers to the risk that the issuer will default on the payment of principal or interest. It is the default risk for most investors. 
• Interest Rate Risk: This refers to the risk that changes in interest rates will negatively impact the bond's price. So, the price falls if market rates rise and vice versa. 
• Liquidity Risk: Bonds with lower liquidity usually have higher yield spreads, particularly in volatile markets. A majority of the corporate bond market is dominated by institutional investors, which leads to higher liquidity risks. There is always difficulty in selling illiquid or unlisted bonds. 
• Market Risk - There is always the risk of fluctuations in bond prices due to various macroeconomic factors and market movements. 

• Prepayment Risk - In the case of a callable bond, there is a risk of early redemption by the issuer. As a result, it may lower the returns of the bondholder. 

How to Evaluate Bond Safety and Return

These are some ratios you can use to evaluate bond safety and returns. 

• Interest Coverage Ratio = EBIT / Interest Expenses 

This measures the company's ability to pay interest. It is calculated by subtracting Earnings Before Interest and Taxes (EBIT) from the interest expenses. This is a vital metric for examining the company’s ability to meet interest payments and the risk associated with its bonds. A higher ICR (Interest Coverage Ratio) indicates a higher ability to cover interest payments and lower default risks (and vice versa). 

• Debt-to-Equity Ratio = Total Debt / Total Equity

Understanding a company’s leverage and financial stability is crucial before investing. This financial metric will help, as it divides the total liabilities of the organisation by its total equity. It refers to the portion of a company's financing that comes from debt as compared to equity. 

A higher ratio indicates a greater dependence on debt, which may increase financial risks, while a lower ratio may indicate a more stable financial scenario. You can thus evaluate the creditworthiness of the company by this ratio and determine your investment risk accordingly. 

• Profitability & Cash Flow: Trends in revenue, profit margins, and asset usage

You should carefully review the company's revenue trends, along with its overall profit margins and asset utilisation. Examine past defaults and debt restructuring closely, along with the maturity schedule of your existing debt. Bond credit ratings by agencies like CRISIL, CARE, and ICRA. 

Tax Implications

So, what are the tax implications of these investments? Let us look at it below: 

• Interest on taxable bonds will be subject to taxation at the investor's applicable income tax slab rate. 
• Capital gain or loss occurs whenever the bonds are sold for more or less than their purchase price. The capital gain taxability varies for listed and unlisted bonds. 
• For listed bonds, if they are held for 12 months or more, they are taken as LTCG (long-term capital gains) and taxed at 12.5% without indexation. 
• Alternatively, they are perceived as short-term capital gains (STCG) and taxed at the applicable slab rate. 
• Unlisted bonds matured, transferred, or redeemed on or after July 23, 2024, will always be considered as STCG, irrespective of the holding period, as per Section 50AA. 
• TDS is also levied on all interest income generated from bonds as per Section 193. The rate is 10% for all listed and unlisted bonds. 

Final Thoughts 

More companies are issuing corporate bonds in India, which brings security along with the chance to earn profits. For those who wish to stick to fixed-income securities, as well as those who want a wider range of investment choices beyond equities, understanding corporate bonds is important.

Monitor the issuer's financial standing, define the type of bond, and exercise extra caution when reviewing the offer document. Taking time to study the market, corporate bonds can help investors reach their financial goals over time.