Investing In Corporate Bonds: Key Terms To Know

Bonds are fixed-income investment options that are used by governments and companies to raise funds for specific purposes. 

They can be a great way to diversify your portfolio and hedge oneself against market fluctuations. This article will discuss the key terms you need to know before investing in bonds. 

However, before we get into the details, here’s a quick overview of the different types of bonds that are available in India. 

Types Of Bonds

What Are Corporate Bonds?

Consider a corporate bond as a loan that a company takes from its investors, with a promise to repay it at a predetermined date in the future with interest. This money can be used to grow the business, pay bills, make capital improvements, make acquisitions or for any other business needs. 

However, before investing in corporate bonds, here are some key terms that you should know:

Corporate Bonds: Key Terms To Know

1. Bond Issuer

This is the entity which is issuing the bond in exchange of a promise of interest payments at regular intervals and return of the principal amount upon maturity.

2. Bond Holder

This is the lender who lends money to the bond issuer. 

3. Face Value

Also known as par value, this is the designated value per unit of a bond when the bond is issued by the issuer. This is also the amount that the issuer pays to the bondholder when the bond matures.

4. Market Value

This is the value at which the bond is currently being bought and sold in the market. The market value of a bond can be either at a premium or at a discount to the face value. 

5. Maturity

This is the date on which the principal or par amount of the bond is paid to investors.

Depending on their maturity period, bonds are usually classified into three:

• Short-Term: These have a maturity period of one-three years.
• Medium-Term: These have a maturity period of four to 10 years.
• Long-Term: These have a maturity period of more than 10 years.

6. Coupon Rate

Coupon rate is the periodic rate of interest paid by bond issuers to the bondholders on the bond’s face value (also known as par value). 

For example, if you have a 10-year INR 5,000 bond with a coupon rate of 10 per cent, you will get INR 500 every year for 10 years. 

This amount is paid as per a predetermined schedule - monthly, quarterly, bi-annually, or annually until the date of maturity.

And this amount remains the same despite the change in price of the bond in the market.

7. Yield To Maturity (YTM) 

It is the total returns that a bond will give if the bondholder holds it until maturity, all payments are made as scheduled and all the proceeds are reinvested in the same.

8. Internal Rate of Return (IRR)

The internal rate of return (IRR) is the annual rate of growth that an investment is expected to generate. It factors in the timing of returns and the number of returns received. It is a preferred way of measuring investments, especially those with returns received over a period of time, such as SDIs. You can read more on this topic here.

9. Secured/Unsecured

A bond is classified as a secured or unsecured bond depending on the collaterals backing it.

• Secured Bonds 

These are bonds that are backed by assets like property, equipment or income stream. This provides a safety net to the bondholders in case of any default, as the holder can claim repayment by liquidating the underlying assets. Secured bonds are generally safer and have lower interest rates compared to unsecured ones.

• Unsecured Bonds

Also known as debentures, these bonds are not backed by any specific collateral. Herein, the bondholder is completely reliant on the issuer's financial stability and creditworthiness. These often offer higher interest rates considering the higher risk.

10. Credit Rating 

This is the rating provided by an external agency such as ICRA, Crisil or CARE indicating the ability of the issuer to repay the bond. 

AAA is the highest rating, while D indicates default. 

• Investment Grade

Bonds rated BBB and above, with low chances of default are categorised as investment grade. These usually provide comparatively lower returns given the lower risk profile. 

• Junk Bond

Bonds rated BB and below, with comparatively higher chances of default are categorised as a junk bond. These usually provide higher returns to compensate for their risky profile.

11. Default

A bond issuer is said to have defaulted if it has failed to pay the interest of principal amount when due.

Conclusion

Investing in corporate bonds can greatly benefit an investor. Being a fixed-income investment option, they help in diversifying one’s portfolio and hedging oneself against market volatility. They also offer a fixed regular income, and higher returns compared to other fixed-income opportunities such as FDs. Although, akin to any other investment tool, corporate bonds come with certain risks. An investor, therefore, must closely assess his/her financial goals and capabilities, risk appetite before taking a decision. Carrying out due diligence regarding the issuer and asset is also a must.   

The curated, rated, regulated and secured investment options on Grip Invest can help you make the most of your investments in corporate bonds.

Frequently Asked Questions About Corporate Bonds

1. What is a corporate bond?

In simple terms, a corporate bond is a loan that a company takes from its investors, with a promise to repay.

2. Is investing in corporate bonds a good idea?

Yes, corporate bonds can help diversify your portfolio and hedge oneself against market volatility. Although one must go through the terms and conditions and potential risk associated with the asset at length before investing.

3. Is a corporate bond a debt instrument or an equity instrument?

A corporate bond is part of the debt market, where debt securities, also known as fixed income securities, are issued and traded. Issuers in the debt market include governments, municipal corporations, financial institutions, REITs etc.

4. How do bonds help in the diversification of a portfolio?

Being fixed-income opportunities, bonds help in balancing the volatility associated with stocks and mutual funds.

5. How are bonds different from stocks?

Simply put, investing in stocks will give you ownership to a small portion of the company. On the other hand, while investing in bonds, you are lending the company or money to fund their needs/projects.

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