Corporate bonds in India present a unique investment opportunity, offering a blend of potential rewards and manageable risks. Unlike government-issued bonds, corporate bonds are issued by companies from private and public sector undertakings (PSUs). These financial instruments play a crucial role in diversifying an investor’s portfolio and can offer higher returns than traditional fixed-income assets.

What are Corporate Bonds-

Corporate bonds are debt securities corporations issue to raise capital for various business purposes. These bonds are governed by the Companies Act of 2013, which stipulates the legal framework for their issuance and management. The corporate bond market in India is diverse, encompassing bonds issued by private sector companies and PSUs, each offering unique attributes and risk profiles tailored to a wide range of investor preferences.

How Do Corporate Bonds Work-

When investors buy corporate bonds, they lend money to the issuing corporation in exchange for regular interest payments. The interest, known as the coupon rate, is paid periodically and is determined by the bond terms. Upon maturity, investors receive their initial investment (principal) back. However, if the bond is sold before maturity, the investor might receive more (capital gains) or less (capital loss) than the original investment, depending on market conditions. This variability is referred to as price risk or interest rate risk.

Types of Corporate Bonds in India

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

By Issuer Type-

1. Private Sector Bonds– Issued by private companies like HDFC Bank or Reliance Industries.
2. PSU Bonds– Issued by public sector undertakings like UP Power Corporation or HPCL.

By Credit Rating-

Credit ratings indicate the bond issuer’s financial strength and repayment capability, ranging from AAA (highest) to D (lowest).

• AAA and AA Rated Bonds– Suitable for low-risk investors as they are considered the safest.
• A Rated and Lower– Offer higher yields to compensate for the increased risk, commonly called ‘ high yield bonds.’

Corporate Bonds vs Government Bonds

Corporate bonds generally offer higher returns compared to government bonds but come with increased risk. This trade-off is a key consideration for investors. Backed by the government, PSU bonds are perceived as safer than private sector bonds. For instance, a bond issued by Power Finance Corporation (a PSU) might be less risky than one issued by Tata Motors Finance Solutions (a private company).

Are Corporate Bonds a Good Buy-

Corporate bonds are a good investment for those willing to take on some risk within the fixed-income asset class. They offer higher returns compared to government bonds, making them attractive for investors who can handle additional risk. Many investors prefer corporate bonds over fixed deposits for the debt allocation in their portfolio due to the potential for higher returns.

Are NRIs Eligible to Invest in Corporate Bonds-

Non-resident Indians (NRIs) can invest in corporate bonds issued by PSUs. However, they are not eligible to invest in corporate bonds issued by private sector companies. This limitation is crucial for NRIs planning their investment strategies.

High Yield Corporate Bonds

Corporate bonds with A and lower credit ratings are classified as ‘ high yield bonds’  due to their higher interest rates. These rates attract investors by compensating them for the higher risk associated with these bonds. High-yield bonds can be lucrative, but they require careful consideration of the issuer’s financial health and market conditions.

Taxation of Corporate Bonds

Understanding the taxation of corporate bonds is essential for investors-

• Interest Income– The interest earned from corporate bonds is added to the investor’s annual income and taxed according to their marginal income tax slab rate.
• Capital Gains–
  • Listed Corporate Bonds–
    • Long-term capital gains (holding period > 36 months)- Taxed at 10% without indexation.
    • Short-term capital gains (holding period < 36 months)- Taxed at the investor’s marginal tax rate.
  • Unlisted Corporate Bonds–
    • Long-term capital gains (holding period > 12 months)- Taxed at 20% with indexation.
    • Short-term capital gains (holding period < 12 months)- Taxed at the investor’s marginal tax rate.

How Risky Are Corporate Bonds-

The risk associated with corporate bonds varies based on the issuer’s credit rating and other factors, such as market conditions. Key risks include-

• Credit Default Risk– The risk that the issuer will not make interest payments or return the principal.
• Duration Risk– The risk of bond price fluctuations due to interest rate changes.
• Liquidity Risk– The risk of being unable to sell the bond easily at a favourable price.
• Reinvestment Risk– The risk that interest or principal repayments will have to be reinvested at a lower rate.

AAA-rated bonds are the safest and should be chosen by the most conservative investors. Conversely, lower-rated bonds offer higher yields but come with increased risk.

Conclusion

Corporate bonds in India offer a compelling investment opportunity with a balance of potential rewards and manageable risks. By understanding the various types, benefits, risks, and tax implications of corporate bonds, investors can make informed decisions that align with their financial goals and risk tolerance. Whether seeking higher returns than government bonds or diversifying a fixed-income portfolio, corporate bonds can be a valuable component of a well-rounded investment strategy.

Also Read: Big rise in scope for NRI investments