Government Bonds Vs. Corporate Bonds: A Quick Guide
Fixed-income investments are available in many forms, but corporate bonds and government-issued bonds are the largest part of the fixed-income market open to investors. If you are an investor looking to invest in bonds, you are likely to buy one of these two securities.
However, selecting the ideal option that contributes to a balanced portfolio can be tricky. While these investments appear similar in many ways, learning their differences can help you choose the one that aligns better with your financial objectives.
Read the article to find which investment is suitable for you and make an informed choice. But first, it is essential to know what bonds are to understand the concept better.
What Is A Bond?
Let us begin by learning what bonds are. Simply put, a bond is a loan the bondholder or investor makes to the issuer. Corporations, governments and municipalities issue bonds to raise capital and obtain funds from investors who purchase them. Hence, if you invest in a bond the issuer will pay interest to you over the period of investment and the principal amount on the maturity date.
According to a leading credit rating agency CRISIL1, the corporate bond market in India is expected to reach INR 100 - 120 lakh crores by the financial year 2030.
This represents the huge investment potential that the corporate bond market offers to investors. But before that, let us first understand the different advantages that you can get while investing in bonds.
Advantages Of Investing In Bonds
Now that you have a basic idea of what is a bond, you can consider adding them to your portfolio. To make a sound decision, assessing your investment options and their benefits is crucial. Here are some primary advantages of investing in bonds:
- Low Initial Investment:
Bonds can be incredibly economical investments, starting with face values as low as INR 1,000. Most Bonds however have been available for a face value of INR 1,00,000. To encourage the growth of the Bond market for retail investors, SEBI has recently reduced the minimum face value to INR 10,000. - Fixed Returns:
Investing in bonds typically brings a steady stream of income. The returns are mostly assured by the Issuer or the Bond, fixed and known in advance. Market volatility has no impact on interest returns from bonds. - Credit Rating:
The companies that offer bonds are usually rated by credit rating agencies and this can help the investor in deciding whether to buy the bond from that Issuer or not. ‘AAA’ rated bonds are considered to be the safest. - Portfolio Diversification:
An investor can diversify his portfolio by the way of investing in bonds since bonds are not subject to market-related risks and returns.
Example Of A Corporate Bond
A mobile phone manufacturing company plans to build a new factory, which requires INR 50 million. To finance this, it issues corporate bonds with a face value of INR 10,000, at a 12% annual interest rate, and a 5-year maturity.
Say you purchase bonds of INR 100,000. You will receive INR 12,000 (12% of INR 100,000) yearly as interest. After 5 years, you will also receive back your initial INR 100,000 investment. This way, the company will be able to raise the required capital, and you can earn through interest payments.
Example Of A Government Bond
Suppose the Government of India requires funding for infrastructure projects. The government bond has a face value of INR 10,000, an annual interest of 7%, and a 10-year maturity period.
If you purchase this bond and lend INR 10,000 to the government, you will earn 7% interest on INR 10,000 (INR 700) per year. This will help you earn guaranteed returns while the government receives the funding.
Corporate Bonds Vs. Government Bonds
The table below presents an overview of the key differences between corporate bonds and government securities.
Aspect | Corporate Bonds | Government Bonds |
Issuer | Public and private sector corporations issue corporate securities and bonds. | The Reserve Bank of India issues the securities on behalf of the Central or State government. Additionally, municipal corporations and state authorities also issue government bonds. |
Regulatory Authority | The Securities And Exchange Board of India (SEBI) and the Securities Contract (Regulation) Act govern these bonds. | The RBI regulates the investments in Government Bonds. |
Risk Profile | Corporate bond investing has low levels of risk. This is best represented by the credit rating of the Bond. For example ‘AAA’ rated bonds have seen nil default over the last 10 years as per CRISIL. While as the default rates on a ‘A’ rated Corporate Bond have been around 1.0% | Government securities have a national guarantee and therefore, are safe investment choices. |
Returns | These bonds offer potentially higher returns because there are chances of greater returns for the investor. Returns typically range from 9-14% | Returns in government securities are relatively lower depending on the tenure and other economic variables but guaranteed. Returns are typically 7-8% |
Liquidity | These bonds are less liquid. | These bonds are more liquid. |
Interest from corporate bonds is subject to tax. | Interest from government bonds is subject to some tax benefits. For example: Section 80CCF offers tax-saving benefits for investment in government-approved infrastructure bonds. Taxpayers can avail a deduction of up to INR 20,000 per year. |
Conclusion
Government bonds and corporate bonds are ideal instruments for anyone seeking to invest in fixed - income opportunities. Government bonds accompany minimal credit risk but pay lower interest rates. Corporate bond investing carries low levels of default risk but compensates you with higher yields.
Overall, determining which investment is better— corporate bonds vs government bonds— depends entirely on your investment objective, risk tolerance and financial situation. You can also consider investing in both for a risk-free inflation-adjusted return.
Follow Grip Invest to learn more about safe investment choices and explore listed regulated and rated high-yield corporate bonds.
Frequently Asked Questions On Bonds:
Q1. Which one is better - corporate bonds or government securities?
Corporate bonds have a certain level of risk but bring higher and better returns than government securities. Meanwhile, government bonds contain a sovereign guarantee and thus, are a safe investment. As a result, the most suitable investment option can vary depending on the objective.
Q2. What returns can I expect from corporate bonds?
Corporate bonds offer higher returns when compared to other debt instruments. The investment grade corporate bonds (rating BBB or above) can offer you a high yield of up to 14% on Grip Invest.
References:
1. CRISIL <https://tinyurl.com/2mjvnmr4>
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