Understanding Bond Redemption: A Comprehensive Guide

India’s emergence as a global economic superpower owes much to its thriving bond market, driving innovation and growth in infrastructure and industries at large.

As of March 2024, the value of the Indian bond market stands at a whopping INR 217 trillion, or $2.56 trillion and underlines the very importance the bond market enjoys in the financial architecture of the country¹.

Currently, corporate bonds constitute 22% of the total outstanding in India’s bond market. Though money market instruments are less than 10%, G-secs represent the majority, followed by state development loans (SDLs) and corporate bonds. 

Corporate bonds are attractive to investors since they can offer higher potential returns. For those investing in corporate debt - knowing how issuers repay bondholders at maturity is key. 

This article explains the different types, terms, and approaches related to redeeming corporate bonds, offering useful perspectives to help investors effectively navigate this changing terrain.

Understanding Corporate Bond Redemption

Bond redemption involves the repayment of the original principal amount to the bondholder at maturity. 

However, some bonds allow for early redemption; either the issuer can exercise a call provision to redeem, or the investor can exercise a put provision to redeem. If a bond is paid off at either its maturity or before it as well is considered redeemed, where the bondholder would receive, not only the amount originally invested but also the interest that was accrued over the period since the last interest payment was made.

Key Corporate Bond Redemption Terms 

In order to understand the process of the repayment of bonds, understand these concepts: 

• The face value is the value of the bond at the time of its maturity and in most cases, it is one thousand rupees in India.
• The date of maturity is the date on which the bond issuer pays the bondholder the amount which was borrowed with an agreement of its return being on the specified date (the Principal Amount).
• Redemption yield signifies the total return the bond investor makes - consisting of interest earned and any price increases until the bond is repaid at maturity.

Different Types Of Corporate Bond Redemption

Bonds can be redeemed in various ways; here are some ways: 

1. Maturity Redemption

Redemption at maturity means that the issuer of the bond gives back to the bondholder the full face value of the bond at a maturity date. This is agreed upon at the time of issuance. 

Let us assume that a company issues a bond with the following terms:

In other words, at the end of 5 years, the company will repay the bondholder INR 1,000. 

Furthermore, the bondholder has also earned 5% annual interest over 5 years:

Annual Interest: INR 1,000 × 5% = INR 50

Total Interest Over 5 Years: INR 50 × 5 = INR 250

The total of the principal amount and the interest will be INR 1,000 + INR 250 = INR 1,250.

2. Call Redemption

A callable bond is a type of bond that allows the issuer to repay the principal amount before its scheduled maturity date. The issuer usually does so when the market interest rates decline. This becomes possible because, at lower interest rates, the issuer can refinance debt cheaply.

While this saves the issuer on interest costs, it imposes a kind of reinvestment risk on the investor. Investors receive their principal earlier than anticipated and may need to reinvest the funds at the current lower interest rates.

Understand the callable bond mechanism by taking an example of Company ABC. ABC issues a callable bond with a face value of INR 1,000, coupon rate is 5%, and maturity period is 10 years.

In this case, in the initial five years from this issue date, if interest rates decline to less than 3%, then company ABC will have the option to call the bond at a premium of 2%.

In case the issuer redeems after three years, then the investors will be paid INR 1,020 instead of the standard amount of INR 1,000.

3. Put Redemption

Put redemption is the procedure linked to putable bonds, where bondholders have the right to resell the bond to the issuer before it is due. It finds significance in a bullish interest rate environment, where the bondholders can sell the bonds and invest in new ones with higher yields. It confers bondholders with greater flexibility and reduces their losses ensuing from bad market conditions.

Say now you buy from XYZ Corporation a 10-year putable bond with a face value of INR 1,000 and a 5% coupon.

At the end of 5 years - the market interest rates climb to 7%. Thus, the market value of the bond is INR 980 just because fixed-coupon bond prices decrease due to rising interest rates.

The execution of the put option allows you to redeem the bond at INR 980 and invest the proceeds at a higher interest rate of 7%.

4. Conversion Redemption

Conversion redemption involves converting the bonds into equity shares in the issuing company instead of redeeming them. It is essentially exercised when the company’s stock performs well or offers ample opportunity for returns for the investor. 

It provides a perspective of a mix between fixed-income stability and the possibility of equity growth, as adopted by those investors seeking this combination.

5. Staggered Payments Redemption

Staggered payment redemption is a method where the principal amount is paid back in multiple instalments instead of all at once. This reduces the burden of repayment on the issuer while providing, step by step, an easily predictable and steady cash inflow for the bondholder. 

It is most often used in large infrastructure or long-term development projects where revenue from such a project is generated in phases.

Key Factors Influencing Bond Redemption

There are several factors that impact the corporate bond redemption of the bond: 

• Interest Rates: Declining rates make callable bonds redeem early. Rising rates affect putable bonds. 
• Financial Well-being of Issuer: A financially sound issuer would be able to finalise redemption terms quite smoothly.
• Type: Callable, putable, or convertible bonds have specific redemption clauses in which redemption terms define timing and payment terms.

Tax Implications of Corporate Bond Redemption

Interest and capital gain are two modes through which investors earn from bonds. The interest, which is the regular income received from the bond during its term, is added to the gross total income of individuals and taxed based on the slab rate.

If a bond is sold for more than the purchase price, then that would be known as capital gain. 

For listed bonds, if a bond is redeemed before 12 months, STCG or short term capital gain is charged at applicable slab rates. If redeemed after 12 months, LTCG or long term capital gain is levied at 12.5% without indexation.

For non-listed bonds, tax is taxed at applicable slab rates for both short and long term gains.

Conclusion

Corporate bond redemption is a key component of bond investing and should be understood by all investors. Understanding types of redemption to the factors that influence them, and tax implications will really help in guiding investment decisions. Whether it is a simple maturity bond, or more complex options like callable or convertible bonds, knowing how and when redemption happens ensures a more peaceful investment experience.

Corporate bonds can prove to be lucrative for people interested in stable returns only with due regard to the issuing company’s credibility and redemption terms.

Invest in corporate bonds that are rated, regulated and provide high returns with Grip Invest!   

Frequently Asked Questions On Bond Redemption

1. How long does bond redemption take?

The time to redeem a bond depends on the bond type and the issuer. Investors should review the specific redemption timelines stated in the bond’s terms and conditions. They should also make sure their account details with the issuer are current to prevent any delays in receiving redemption payments.

2. What does ‘redeemed at a premium’ mean?

The issuer pays back more than the stated value of the bond when bonds are repurchased at a premium, frequently as an incentive for early payback. This premium encourages bondholders to consent to the premature conclusion of the bond agreement. Paying a premium is common with callable bonds, where issuers make the most of decreasing interest rates to refinance debt.

3. What happens to bonds that are not redeemed upon maturity? 

Bonds that are not paid back at maturity are in default. This can trigger legal action by bondholders or regulators. Investors in defaulted bonds may experience delays getting their money back and should focus future investments on financially sound issuers.

References

1. NSE, Accessed from https://nsearchives.nseindia.com/web/sites/default/files/inline-files/NSE_Assocham_Corporate_Bond_Report_2024.pdf

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