What are Corporate Bonds? Its Feature & Benefits
Corporate bonds are debt security which is issued by a corporation and issued to bondholders/investors. An investor who invests in these bonds is lending money to the corporation and in return gets interest along with the principal amount. The money raised by the issuance of the bonds is typically used to finance expansion, acquisitions, or other projects.
In this article, the topics covered:
▪ What are corporate bonds?
▪ What are the kinds of corporate bonds?
▪ Who should invest in corporate bonds?
▪ What are the features and benefits of corporate bonds?
▪ Risk factors and returns
Let us understand, the concept of corporate bonds
Corporate bonds are debt instruments that are issued by corporates with more than one year of maturity. Usually, when we invest in stocks, we own equity in the company but when we invest in corporate bonds we don’t own any equity in the company. The company pays us the interest on the principal which is our profit. Whether the company is in high profits or extreme loss, it is obliged to pay its investors interest and principal to the bondholders.
What are the kinds of corporate bonds?
These are the most common type of corporate bonds:
Fixed Rate Bond:
In this, a coupon rate is fixed during the time of investment and the company pays the bondholder this predetermined coupon rate till the time of maturity.
Zero Coupon Bond:
These bonds are available at a discount but these bonds do not pay regular interest to the investors. So, the investor’s profit is the difference between the final value of the bonds during the time of maturity and the discounted price at the time of buying.
As the name suggests, the interest gained from this bond is completely tax-free and issued by Public Sector Undertakings to raise funds for different projects.
These bonds are convertible and can be converted into equity stocks. On the date of maturity, the issuer of the bond can convert the bond into equity shares and the bondholder will become the shareholder. The issuer won’t be obliged to pay any interest in the future.
Who should invest in corporate bonds?
India is a hub for business and investment opportunities. In recent years, the country has been seeing an influx of people investing in corporate bonds, and is expected to continue in the coming years as well. Corporate bonds are one of the many investment options available, but who should invest in them?
- Investors looking for exposure to the market can consider investing in corporate bonds. This is because corporate bonds offer stability and income, which are two key factors to look for when making an investment decision.
- Investors who are looking for an alternative to traditional fixed-income instruments can also consider corporate bonds. This is because corporate bonds offer higher interest rates than government bonds and are less risky than equity investments.
- When considering whether to invest in corporate bonds, potential investors should consider the financial stability of the issuer, as well as the coupon rate and maturity date of the bond.
- Finally, investors who want to diversify their portfolios can also consider investing in corporate bonds.
What are the features and benefits of corporate bonds?
The features and benefits of corporate bond funds can be discussed below-
As compared to other government bonds or bank FDs, corporate bonds we more profitable as they provide higher returns.
If one invests in good credit-rated bonds i.e AAA+ or AAA-rated bonds then there is low risk involved making it a safer option. These bonds are a great choice for investors with low-risk appetites.
Corporate bonds are very easy to buy or sell after their issuance, which makes it easy for bondholders to sell or buy the bond according to the price fluctuations in the market.
Corporate bonds have a shorter tenure as compared to Government securities. These bonds have a time duration of around 60-120 months.
High Coupon Rates
Corporate bonds not only have shorter time duration but also offer higher coupon rates as compared to government securities. Government securities offer coupons of around 6% whereas corporate bonds offer around 7-12% based on their credit rate.
An insurance company provided a guarantee to make sure of the timely payment of interest and principal to the investor. This is also called “Financial guarantee insurance”.
Risk factors and returns of Corporate Bonds
Corporate bonds add diversification to investors' portfolios and provide steady income through interest. But before investing in these bonds one should also look at the risk factors involved. When you give a loan to someone, there is always some risk involved if your money will be returned with interest or not. The same happens in the case of corporate bonds, and these are called credit risks. It is always advisable to hold bonds of companies with high credit ratings like AAA+ OR AAA. These companies are more trustworthy and the chances of your money loss are very less in these companies. Companies with poor credit ratings are called junk bonds and carry very high risk.
Just like stocks, Corporate bonds also have market risks. Another risk factor involved is interest rate risk. The interest rate is inversely proportional to the market value of the bond and the past performance structure of the bond cannot ensure the future interest rates rise or fall.
In conclusion, corporate bonds offer many benefits, including the potential for higher returns, low risks, high liquidity, high coupon rates, and diversification. However, before investing, it's important to research and understand the risks associated with it.
Corporate bonds are a great choice for investors who are looking to diversify their portfolios without taking much risk. Before choosing any bond, make sure you check their credit rating and select the best credit-rated bond for high returns and low risk.
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