Corporate bonds are debt securities issued by private and public corporations. Companies issue corporate bonds to raise money for a variety of purposes, such as building a new plant, purchasing equipment, or growing the business. When one buys a corporate bond, one lends money to the “issuer,” the company that issued the bond. In exchange, the company promises to return the money, also known as “principal,” on a specified maturity date. Until that date, the company usually pays you a stated rate of interest, generally semi-annually. While a corporate bond gives an IOU from the company, it does not have an ownership interest in the issuing company, unlike when one purchases the company’s equity stock.
FEATURES AND BENEFITS OF CORPORATE BONDS:
- Higher Return : Corporate funds ensure significantly higher returns than other debt instrument in the market. Average yields of 8-10% can be expected from corporate debt instrument , while government – held bonds only provide approximately half of it.
- Liquidity: Since corporate debt funds are generated to satisfy the short term requirements of a business , they too short term in nature . Also, corporate bond can be obtained and sold as per the wish of the investor. This provides high liquidity of the financial resource , allowing a person to convert it to cash as and when the need arises.
- Security: Corporate debt funds have a lower associated risk than shares, as the former poses a financial obligation on the company.
- Coupon (interest) : When you buy a bond, the company will payout interest regularly until you exit the corporate bond or the bond matures. This interest is called the coupon, which is a certain percentage of the par value.
- Tax-efficiency: If you are holding your corporate bond fund for less than three years, then you must pay short-term capital gains tax (STCG) based on your tax slab. On the other hand, Section 112 of the Indian Income Tax mandates 20% tax on long-term capital gains. This applies to those who hold the bond for more than three years.
TYPES OF CORPORATE BONDS:
- Security of bonds: Security for bonds suggests some kind of underlying asset that backs up the issue. This is preferable for investors, as it provides risk protection against a potential corporate default. Assets backing the bond provide security beyond the credit of the issuer.
- Mortgage bond: Bonds can be backed by different assets. For example, bonds that are backed by mortgages are mortgage-backed securities (MBS). A mortgage bond gives the bondholders the ability to sell mortgaged properties to satisfy any unpaid obligations to bondholders.
- Collateral trust bonds: Collateral trust bonds are similar to mortgage bonds except houses are not used to back up the bond. These are used by companies that do not own fixed assets or real property. Instead, these companies own securities of other companies. When issuing bonds, they pledge such stocks, bonds, or other investments that they own in other companies.
- Equipment trust certificates Equipment trust certificates usually revolve around the rental of equipment. For example, assume a railway company needs some cars and orders them from a manufacturer. The manufacturer will complete the order and transfer the ownership of the cars to a trustee. The trustee will then sell equipment trust certificates to investors to pay the manufacturer for the cars. To continue to pay interest on the ETCs, the trustee collects rental fees from the railway company. Upon maturity of the note, the railway company then receives the titles to the cars from the trustee. The renting of the railway cars is not a true leasing arrangement, due to the fact that the railway company will get title to the cars at the end of the ETC agreement. Thus, in essence, equipment trust certificates are a type of secured debt financing.
- Guaranteed bonds: As the name suggests, guaranteed bonds are bonds that are guaranteed. The guarantee is provided by another corporation. This helps decrease the default risk, as another corporation has agreed to step in and fulfill the convenants of the bond if the need arises.
HOW ARE BONDS RATED?
Bonds are rated on the quality of their issuer. The higher the issuer’s quality, the lower the interest rate the issuer will have to pay, all else equal. That is, investors demand a higher return from corporations or governments that they view as riskier.
Bonds broadly fall into two large categories based on their rating:
- Investment-grade bonds:Investment-grade bonds are viewed as good to excellent credit risks with a low risk of default. Top companies may enjoy being investment-grade credits and pay lower interest rates because of it.
- High-yield bonds:High-yield bonds were previously referred to as “junk bonds,” and they are viewed as more risky, though not necessarily very high risk, depending on exactly the grade and financial situation. Plenty of well-known companies are classified as high-yield while continuing to reliably make their interest payments.