All you need to know about corporate bonds

Apart from equity capital, companies also use debt to fund their operations and expansion. One mode of raising debt is corporate bonds. These can be for both long-term and short-term requirements. These bonds are issued to financial institutions, mutual funds, foreign investors, and also 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 just like a bank or an NBFC that gives a loan to a company. 

What are the different types of corporate bonds?

Based on parameters like type of collateral, credit rating, and interest rate, corporate bonds are split into multiple categories:

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. These bonds have lower risk as compared to junk-rated bonds, and hence have a comparatively lower coupon or interest rate.

Those bonds issued by companies with a credit rating below Baa or BBB are usually referred to as junk-rated bonds. Junk-rated bonds are usually considered to have a very low credit rating, hence the interest payable on these bonds are higher. These bonds are high-risk, high-return financial instruments.

2. Convertible and non-convertible bonds

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

3. Floating and fixed-rate bonds

Floating-rate bonds have variable interest as per the market scenario and an external benchmark like the RBI’s repo rate. On the other hand, Fixed-rate bonds offer a predetermined interest rate, which remains constant throughout the tenure.

4. Secured and unsecured bonds

Secured bonds are fully covered by collateral and offer lenders an assurance that they can recover the loan amount in case of default from the borrowing company. These are usually identified assets that have a charge registered against them for the bonds under consideration. On the other hand, unsecured bonds have no collateral. In case of a default, unsecured bonds are paid off by liquidating all unencumbered assets of the company, and any proceeds left from secured assets (against loans) that may remain after paying off the secured creditors (including secured bond investors).

5. Zero-coupon Bonds

Zero-coupon bonds do not pay their holders regular coupon payments or interest. These bonds are issued at a discount to their face value. For example, a Rs 100 face value bond is issued at Rs 80 to the investor. This means the company only receives Rs 80 on a loan of Rs 100. At maturity, the entire face value of the bond is repaid. Through this process, the investor/lender has earned Rs 20 on the bond.

What are the benefits of investing in corporate bonds?

Some of the advantages of investing in corporate bonds are as follows: 

• Steady income - Corporate bonds usually have fixed interest rates. Furthermore, bondholders usually receive coupon payments at regular intervals.

• Diversification - Corporate bonds allow for an opportunity to diversify your investment portfolio. Furthermore, you can use it to reduce the overall risk profile of your portfolio as they generate a stable and fixed income.