Corporate Bonds

Corporate Bonds are issued by public & private sector companies to raise capital from investors. These bonds are debt instruments wherein the issuing company makes periodic interest payments to its investors and returns the principal amount on their maturity dates. These bonds serve as an important source of funding for companies looking to finance expansion, manage operations or refinance existing debt.

Companies issue bonds to raise finances for their expansion, new projects, or other financial requirements. Investors who purchase these bonds become creditors of the company. Here’s how corporate bonds work:-

SEBI-recognised credit rating agencies like CRISIL, ICRA, CARE, etc, assess issuer’s financial health and accordingly, assign credit ratings to their bonds. These ratings indicate the likelihood of the timely servicing of the bonds’ interest and principal repayment. As per the SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021, a bond issuer must obtain at least one credit rating from a registered credit rating agency and disclose it in their offer document.

The credit rating scales used by the credit rating agencies range from high (AAA) to low (D) with the higher credit ratings indicating higher chances of receiving the face value amount and interest income on time.

Rating	What It Means	Risk Level
AAA	Highest degree of safety for timely repayment of debt	Lowest credit risk
AA	High degree of safety for timely repayment	Very low credit risk
A	Adequate degree of safety for timely repayment	Low credit risk
BBB	Moderate degree of safety for timely repayment	Moderate credit risk
BB	Moderate risk of default in timely repayment	Moderate credit risk
B	High risk of default in timely repayment	High credit risk
C	Very high risk of default in timely repayment	Very high credit risk
D	Already in default or expected to default soon	In default

Note: Ratings from AA to C may include a “+” or “–” sign depicting the bond issuer’s relative position within the category. For example, AA+ is stronger than AA, and AA– is slightly weaker than AA.

Differentiation Factor	Corporate Bonds	Government Bonds
Issuing Entity	Issued by private sector companies and public sector undertakings (PSUs)	Issued by the Central Government and State Governments (known as State Development Loans – SDLs)
Coupon Rate	Offer higher coupon rates due to higher credit risk risk	Offer lower coupon rates due to sovereign backing
Coupon/Interest Payment Frequency	Coupon repayment can be at monthly, quarterly, half yearly or annual intervals	Usually make coupon payments at half yearly frequencies, based on their issue dates and maturity dates
Credit Risk	Higher credit risk than government bonds due to the risk of default by the issuer	Lower credit risk due to sovereign guarantee
Credit Rating	Must be rated by SEBI-registered credit rating agencies (rating ranges from AAA to D).	Not rated, as these are backed by a sovereign guarantee
Regulatory Authority	Regulated by SEBI	Regulated by RBI

Also Check: Bonds vs FD

You can invest in corporate bonds through Paisabazaar’s website or mobile app. To get started, simply follow the steps below:

Step 1: Login to your Paisabazaar account through an app or website

Step 2: Select the bond after comparing yield (YTM), credit rating and investment amount

Step 3: Complete the KYC process. Keep your Aadhaar and PAN Card handy.

Step 4: Enter bank details for corporate bond purchases, receiving interest and payouts

Step 5: Link your demat account to receive the bond directly to that account.

Although corporate bonds are often seen as safer than equities, they come with their own set of risks that investors must understand and manage wisely:

Credit Risk

Credit risk refers to the situation when the issuer may fail to make timely interest payments or repay the principal. To manage this risk, investors should evaluate the issuer’s financial strength and credit rating. Corporate bonds having higher credit rating have lower credit risk.

Prepayment Risk

Some corporate bonds allow issuers to repay the debt before their maturity dates, especially during a falling interest rate regime. While this benefits the bond issuer, it can leave their investors to invest the bond maturity proceeds in instruments offering lower returns. To guard against this, investors should carefully check for callability or buyback related clauses before investing.

Interest Rate Risk

Bond prices move inversely to interest rates—when rates rise, the market price of the bond falls and vice versa. This risk is higher in corporate bonds having longer residual maturity. Investors seeking to avoid this risk should aim at staying invested in their corporate bonds till their maturity dates.

Liquidity Risk

If a bond is not actively traded, it might be difficult to sell it at a fair price before its maturity date. Thus, a lack of liquidity can lead to losses or delays in converting the investment to cash. Choosing listed bonds having sizeable trading volume can help reduce this risk for the investor.

Also Know: Types of Bonds

Corporate bonds can be categorised on the basis of their periodicity of interest payments, type of interest rate, collateral attached, convertibility and buy-back features.

Corporate Bonds Classification in terms of Interest Rate Type

Fixed Rate Bonds

A fixed-rate bond offers periodic interest payments as per the interest rate fixed at the time of bond issuance. This interest payment, often called a coupon payment, is calculated as a percentage of the face value of the bond. The interest rate is called the coupon rate.

Floating Rate Bonds

A floating rate bond has its interest rate linked to a benchmark like government bond yields or the Mumbai Interbank Offered Rate (MIBOR), etc. As the benchmark rate fluctuates, the interest rate of the bond also fluctuates accordingly. Due to this dependency on the movement of the benchmark rate, the income certainty of the floating-rate bonds is much lower.

Zero Coupon Bonds

Zero coupon bonds do not provide periodic interest payments. These bonds are issued at a discount on the bond’s face value. The bondholder receives the face value of his investment on maturity. The investor purchasing a zero coupon bond profits from the difference between the purchase price and the face value of the bond.

Corporate Bonds Classification in terms of the Periodicity of Interest Payments

Cumulative Bonds

In case of cumulative bonds, their issuers pay back the interest income, accrued over the bond tenure, on their maturity dates. These bonds are suitable for investors who prefer growth over regular income.

Non-Cumulative Bonds

In case of non-cumulative bonds, the accrued interest income is paid out at regular intervals, viz, monthly, quarterly, semi-annually or annually, depending on the interest payment frequency set at the time of bond issuance. These bonds are suitable for investors requiring a steady income stream.

Corporate Bonds Classification in terms of Collateral

Secured Bonds

Secured bonds are backed by specific collateral pledged by the issuing company—such as real estate, machinery, or other tangible assets. In the event of a default or winding up of the bond issuers, the pledged assets of secured bonds can be sold to repay their investors. This added layer of security makes secured bonds less risky compared to unsecured bonds.

Secured bonds can be further classified into senior and junior (subordinated) bonds. Investors holding senior bonds receive higher priority in terms of claim on the issuing company’s assets during liquidation or defaults.

Unsecured Bonds

Unsecured bonds are not backed by any specific collateral of the bond issuing company.

Corporate Bonds Classification in terms of Convertibility

Convertible Bonds

Convertible Bonds can be converted into equity shares of the issuing company. The conversion can either take at a pre-determined price set at the time of the bond issuance or at the prevailing stock price at the time of conversion. As convertible bonds allow their investors to exercise of option of converting them into equity shares, the coupon rates offered on convertible corporate bonds are usually lower than their non-convertible counterparts.

Some companies issue corporate bonds that are to be compulsorily converted to equities on a preset date. Such bonds are known as compulsorily convertible bonds.

Non-Convertible Bonds

Corporate bonds that do not allow their investors the option of conversion to equities of the issuing company are known as non-convertible bonds.

Classification in terms of Buy-Back Options

Callable Corporate Bonds

These bonds allow their corporate issuers the right to exercise buybacks from their existing bond holders before their maturity dates.

Puttable Corporate Bonds

Puttable corporate bonds allow their investors to sell back their bonds before their maturity dates on pre-determined dates.

The company can issue corporate bonds to raise capital through two primary methods: a public issue or a private placement.

Investing through Public Issue vs. Private Placement

In a public issue, the company invites the general public to subscribe to its bonds. Before doing so, the company must issue a prospectus stating details about the company and bonds to be issued – its face value, coupon rates, nature of the instrument (secured or unsecured), maturity dates/tenor, seniority (i.e. senior or sub-ordinate bonds), coupon payment frequency, etc. Once the public issue is completed, the bonds are listed on stock exchanges like NSE or BSE—making them listed bonds.

On the other hand, private placements of bonds in India are usually offered to a select group of persons (not exceeding 200 as per Companies Act, 2013) in addition to qualified institutional buyers.

Investing in Corporate Bonds through Primary Market vs Secondary Market 

Investors can invest in listed bonds primarily through two routes:

Retail investors can purchase and sell corporate bonds through conventional stock brokers and OBPP (Online Bond Platform Providers).

Corporate Bonds are ideal for:-

Understand Whether the Bond Is Secured or Unsecured

Before investing, determine whether the bond is secured (backed by the issuer’s collateral) or unsecured (not backed by collateral). In the case of secured bonds, the collateral can be liquidated to repay investors in case of a default. This provides higher capital protection to secured bond investors. Within the secured bonds category, senior secured bonds have repayment priority over subordinated bonds in case of default. As unsecured bonds are not backed by collateral, they carry higher risk for their investors. This leads companies to pay higher yields on its unsecured bonds to compensate for the higher risk involved.

Liquidity in the Secondary Market

Check how easily the bond can be traded in the secondary market. If you plan to sell the bond before its maturity date or at least want to keep this option open, ensure that the bond is sufficiently liquid in the secondary market with active buyers and sellers. Investing in an illiquid bond may not allow you to sell the bond due to limited market participants.

Credit Rating & Default Risk

Credit ratings (e.g., AAA, AA, A) from rating agencies like ICRA, CRISIL, CARE, etc reflect the issuer’s creditworthiness and default risk. Higher-rated bonds usually have lower chances of default and thus, offer lower yields due to the lower risk for the investors. Conversely, as lower-rated bonds carry higher credit risk, their issuers offer higher yields to compensate their investors. Thus, before investing in any bond, compare the credit rating of multiple bonds, your own risk appetite and your return expectations and then invest accordingly.

Call Option (Callability Clause)

Another important factor to check is whether a bond has a callability clause for its issuer. A bond having a callability clause allows its issuer to redeem it before its maturity date. Companies usually exercise this clause when the market interest rates fall so that the issuer can reduce its interest cost by issuing fresh bonds at a lower coupon rate. However, exercise of this option increases the reinvestment risk for the investor, as the amount received when the bond is called may need to be reinvested at lower yields during the falling interest rate regime.

Issuer’s Financial Health

Investors can analyze the financial health of the company by checking its business model, financial statements, annual reports, various financial ratios like interest coverage ratio, debt to equity ratio, etc. Additionally, also assess whether the company has a history of defaults, has previously rolled over its debt, violated loan agreements or whether it is/was involved in any significant legal disputes. Investors should also check the maturity pattern of the existing loan of the bond issuing company and whether a significant amount of debt would mature soon.

Bond interest income is fully taxable as per the individual’s income tax slab. However, interest income of tax-free bonds issued by REC, PFC, etc are tax free. Thus, investors should calculate the post-tax yield to understand the actual return on their investment and for comparing them with the returns offered by instruments belonging to other asset classes. Additionally, capital gains (if the bond is sold before its maturity at a higher price) generated on selling a bond may be taxed as short-term or long-term capital gains depending on the holding period.

Short term capital gains (STCG), i.e., gains booked within 12 months of the bond purchase, from listed or unlisted bonds are taxed at the slab rate of the investors. Long term capital gains (LTCG), gains booked after 1 year of bond purchase, from listed bonds are taxed at 12.5%.