All You Need to Know About Corporate Bonds

Corporate bonds can add stability to your portfolio. Apart from equity capital, companies also use debt to fund their operations and expansion. One mode of raising debt is corporate bonds, which can be used for both long-term and short-term requirements. These bonds are issued to financial institutions, mutual funds, foreign investors, and retail investors.

What Are Corporate Bonds?

Corporate bonds are debt securities issued by companies to fund their business operations. Investors who invest in corporate bonds essentially lend money to these companies. In return, they receive a specified interest at regular intervals and the principal at the end of the term. Bond investors are essentially lenders to a company, similar to a bank or a Non-Banking Financial Company (NBFC) that provides loans to companies.

What Are the Different Types of Corporate Bonds?

Corporate bonds can be categorized based on parameters such as type of collateral, credit rating, and interest rate:

1. Investment-Grade and Junk-Rated Bonds

Bonds issued by companies with a credit rating above Baa or BBB are usually referred to as investment-grade bonds. A high credit rating indicates lower chances of payment defaults, making these bonds lower risk compared to junk-rated bonds, which offer a comparatively lower coupon or interest rate.

In contrast, junk-rated bonds are issued by companies with a credit rating below Baa or BBB. These bonds are considered to have a very low credit rating, leading to higher interest rates. They are classified as high-risk, high-return financial instruments.

2. Convertible and Non-Convertible Bonds

Convertible bonds are hybrid securities that can be converted into shares of the company at a predetermined price. These can be optionally convertible or compulsorily convertible into shares. On the other hand, non-convertible bonds are plain bonds issued by a company for a fixed maturity period and interest rate, which cannot be converted into equity shares.

3. Floating and Fixed-Rate Bonds

Floating-rate bonds have variable interest rates that adjust according to market conditions and an external benchmark, such as the RBI’s repo rate. In contrast, fixed-rate bonds offer a predetermined interest rate that remains constant throughout the bond's tenure.

4. Secured and Unsecured Bonds

Secured bonds are fully covered by collateral, providing lenders assurance that they can recover the loan amount in case of default. These are usually associated with identified assets that have a charge registered against them. Conversely, unsecured bonds have no collateral backing. In the event of default, unsecured bonds are paid off by liquidating all unencumbered assets, along with any remaining proceeds from secured assets after fulfilling secured creditor obligations.

5. Zero-Coupon Bonds

Zero-coupon bonds do not provide regular coupon payments or interest. Instead, these bonds are issued at a discount to their face value. For example, a Rs 100 face value bond might be issued at Rs 80. At maturity, the entire face value is repaid, allowing the investor to earn the difference as profit.

What Are the Benefits of Investing in Corporate Bonds?

Some advantages of investing in corporate bonds include:

1. Steady Income

Corporate bonds usually offer fixed interest rates, and bondholders typically receive coupon payments at regular intervals.

2. Diversification

Investing in corporate bonds allows for portfolio diversification, which can help reduce the overall risk profile while generating stable and fixed income.

3. Higher Yields

Corporate bonds generally offer higher interest rates than government bonds due to the higher credit risk associated with them. Typically, a high-rated corporate bond provides a lower coupon rate compared to below-investment-grade rated bonds.