Exploring Corporate Bonds in India – A Comprehensive Guide

Exploring Corporate Bonds in India – A Comprehensive Guide

Corporate bonds in India represent a compelling investment option, offering a blend of potential rewards and manageable risks. Issued by both private companies and public sector undertakings (PSUs), these bonds diversify an investor’s portfolio and potentially offer higher returns than traditional fixed-income assets. This blog will delve into the intricacies of corporate bonds, their workings, types, advantages, risks, and tax implications.

What Are Corporate Bonds?

Corporate bonds are debt securities issued by corporations, both from the private sector and PSUs, as a means to raise capital. Unlike government-issued bonds, corporate bonds carry a higher risk but also offer higher returns, making them an attractive option for investors seeking better yields.

How Do Corporate Bonds Work?

When you invest in a corporate bond, you essentially lend money to the issuing corporation. In return, you receive periodic interest payments (coupons) based on the bond’s coupon rate. Upon maturity, you receive the principal amount back. If you sell the bond before maturity, the sale price can result in a capital gain or loss, depending on market conditions and interest rates at the time.

Types of Corporate Bonds in India

Corporate bonds can be categorised based on the type of issuer and credit rating –

1.   Issuer Type –

• Private Sector Bonds – Issued by private companies such as Tata Motors Finance Solutions.
• PSU Bonds – Issued by public sector companies like Power Finance Corporation.

2.   Credit Rating –

• AAA Rated Bonds – These bonds have the highest credit rating, indicating low risk.
• AA Rated Bonds and Lower – These offer higher yields to compensate for higher risks. Bonds rated below investment grade (BBB and lower) are often referred to as “high-yield bonds.”

Corporate Bonds vs. Government Bonds

While corporate bonds generally offer higher returns than government bonds, they come with increased risk. PSU bonds, backed by the government, are perceived as safer than private sector bonds. For example, bonds issued by HDFC Bank and Reliance Industries represent private sector options, whereas bonds from UP Power Corporation and HPCL are examples of PSU bonds.

Are Corporate Bonds a Good Buy?

Yes, corporate bonds are a good buy for investors willing to accept some risk within the fixed-income asset class. They offer higher returns than government bonds but come with additional risks. Many investors prefer corporate bonds over fixed deposits for the debt allocation in their portfolios due to the higher yields.

Eligibility of NRIs

NRIs are eligible to invest in corporate bonds issued by PSUs but not in those issued by private sector companies. This provides a relatively safe investment avenue for NRIs, given the government backing of PSUs.

High Yield Corporate Bonds

High-yield corporate bonds often rated A or lower, offer higher interest rates to attract investors who are willing to take on more risk. These bonds compensate investors for the higher default risk associated with lower-rated issuers.

Taxation of Corporate Bonds

1. Interest Income – Interest earned from corporate bonds is added to your annual income and taxed as per your marginal income tax slab rate.
2. Capital Gains –

• Listed Bonds – Long-term capital gains (held for more than 36 months) are taxed at 10%, while short-term gains (held for less than 36 months) are taxed at the investor’s marginal income tax rate.
• Unlisted Bonds – Long-term capital gains (held for more than 12 months) are taxed at 20% with indexation benefits, and short-term gains (held for less than 12 months) are taxed at the investor’s marginal income tax rate.

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Risks of Investing in Corporate Bonds

Corporate bonds are subject to various risks –

• Credit Default Risk – The risk that the issuer may fail to make interest payments or repay the principal.
• Interest Rate Risk – The risk that changes in interest rates will affect the bond’s market value.
• Liquidity Risk – The risk that the bond may not be easily sold in the secondary market.
• Reinvestment Risk – The risk that the proceeds from a bond may be reinvested at a lower interest rate.

Corporate Bonds vs. Corporate Bond Mutual Funds

The primary difference between corporate bonds and corporate bond mutual funds lies in diversification. Investing in a single corporate bond exposes you to the specific risks of that issuer. In contrast, corporate bond mutual funds spread the investment across a portfolio of corporate bonds, reducing individual issuer risk and offering diversified exposure.

Conclusion

Corporate bonds offer a promising investment option for those looking to diversify their portfolio and achieve higher returns compared to traditional fixed-income assets. While they come with inherent risks, careful selection based on credit ratings and issuer reputation can mitigate these risks. Investors should consider their risk tolerance, investment horizon, and financial goals before investing in corporate bonds.