BONDS – AN INVESTMENT OPTION FOR RETAILERS © Prasad Kelkar

When we think of savings or investment, what comes in our mind is keeping funds in either Fixed Deposits with Banks, National Savings Certificate or MIS with Post Office, Insurance Policies with LIC or other insurance companies.

Now a days with share market reaching sky high, people even have started investing in stocks directly or through mutual funds.

People who have good financial backing go an extra mile and invest in real estate as well.

There are other avenues as well for parking one’s funds and achieving decent returns.  One of such instruments for investment is investing in Corporate Bond or Debentures.

WHAT ARE BONDS?

Company can raise funds through – Equity Financing (selling shares of the company – also known as equity dilution) OR Debt Financing.  Debt Financing can be done either by taking Bank Loan or through raising capital by issuing bonds. 

As Bank Loan is a costly method of raising finance for the company, it is preferable for a company to issue Bonds for raising the finance.  Bonds are also known as Debentures or Debt Securities or Debt Instrument.  This type of investment instrument falls under Fixed Income Securities.

Bonds are issued by either Central Government (Government Securities), State Government (State Development Loans), or by Corporates (Corporate Bonds / Debentures).

There are various types of bonds, but we will for better understanding only focus on plain vanilla bond.  Plain Vanilla Bond is a simple type of bond, which does not have any special type of terms and conditions.

WHAT ARE CORPORATE BONDS?

Corporate Bond or Debenture is a financial instrument through which the company can raise funds.  The person who invests or lends funds is called Debenture holder.

Corporate Bonds can be issued by public and private corporations.  Though features of the Bonds and Debentures have very few differences in their characteristics, they are used interchangeably.

A Bond is issued at a particular rate (Fixed Interest Rate) for a particular tenor (Maturity Date), where interest is payable intermittently (interest payable at monthly / quarterly / half yearly / yearly).  These terms are defined at the time of the issue.  These bonds are also rated by the rating agencies.  These ratings are given depending on the financials and the historical experience of bonds issued by the company.

For example, if HDFC LIMITED has issued a bond on October 20, 2021 for 10-year, interest to be paid annually at 8.75% interest. The nomenclature of the bond will be 8.75% HDFC LIMITED 2031.  Supposing, the Face Value of the bond is Rs.10 Lakhs, then the interest received on every October 20 till 2031, by the investor will be Rs.87,500/- per annum (Rs.10,00,000*8.75%).

The difference between investing in Equity and investing in Corporate Bond is that the investor gets ownership rights if they invest in equity, whereas the investor does not get ownership rights if they invest in corporate bonds or debentures.

Corporate Bonds market in the US or the UK is much larger than their respective Equity Markets.  Whereas, in India the Corporate Bond market is negligible as compared to the stock market.

Securities and Exchange Board of India (SEBI) is the regulator of the corporate bond markets in India.

HOW CAN RETAIL INVESTOR INVEST IN CORPORATE BOND?

Investment in Corporate Bond or Debentures can be done in Primary Market or through Secondary Market.

  • INVESTMENT THROUGH PRIMARY MARKET

As per new regulations, Companies have to raise long term borrowings from Corporate Bond market.  Also, Companies which borrow or raise funds above Rs.200 crore should execute it in Electronic Bidding Platform (EBP) of NSE / BSE.  Interested investors can go to the following websites to get more information about how to invest in corporate bond in primary market.

https://www.nse-ebp.com

https://bond.bseindia.com

  • INVESTMENT THROUGH SECONDARY MARKET

Investment in Bonds can also be done through secondary market.  Investors will have to approach the Banks / Insurance Companies / Primary Dealership / Brokers who can help them in buying the required bond/s.  For buying or selling corporate bonds one needs to have a Demat account.  Also please note that as the big players are regulated by RBI / SEBI, it has been mandated for them to trade only through clearing corporations of NSE or BSE.  The clearing corporation of NSE is called NSCCL and clearing corporation of BSE is called ICCL.  The retail investor also needs to open account with either NSCCL or ICCL.  The retail investor should go for ICCL as ICCL does not levy any transaction charges for buying or selling corporate bonds on their platform.   The retail investors can also open account with NSCCL, but then they will have to pay transaction charges for every transaction they do on their platform.

TERMINOLOGIES OF CORPORATE BOND

PRIMARY MARKET: The Primary Market is where fresh or new securities are created. Companies issue new bonds to the investors through either public issue of private placement.

SECONDARY MARKET: The Secondary Market is the place, where the securities or bonds already created under Primary Market is traded. This also means that buying or selling of the bonds happen between the seller and the buyer directly.  In this trade, neither the buyer or seller is the company which has issued the bond.

ISSUER: The company which issues the bonds / debentures is called issuer of the bond.

ISSUE DATE: The date on which the bond is issued in the market is called issue date of the bond.

 FACE VALUE: This is also called Nominal Value of the bond or denomination of the bond. Usually the face value of bond is Rs.10,00,000/-. Very rarely the face value is Rs.1,00,000/- or Rs.10,000/-

COUPON RATE: Interest rate promised to pay by the company to the investor or buyer of the bond or holder of the bond on the interest date.

 COUPON PAYMENT: Interest amount paid by the company to the investor or buyer of the bond or holder of the bond on the interest date. The interest is paid either on monthly / quarterly / half yearly / yearly basis, based on the terms of issue of the bonds.

 COUPON DATE: The date on which the interest is paid to the investor or holder of the bond on the interest due date.

 ISSUE PRICE: Usually Rs.100/- when the bond is sold by the issuer for the first time. Also called primary market issue.

 MARKET PRICE: When the bond is bought / sold in secondary market the price may differ depending on the demand & supply of the bond and prevailing interest rate. 

MATURITY OR REDEMPTION DATE: This is the date when the principle amount invested is repaid back to the investor. 

REDEMPTION PRICE: This is usually same as the issue price. This may differ depending on the type of bond. 

RATING: The bonds are rated by rating agencies. The AAA rated bond is safer than AA, whereas AA is safer than A, A is safer than BBB, and so on.  Please note that one cannot depend only on ratings while making an investment in Bonds / Debentures. CRISIL, ICRA, India Ratings, etc. are some of the well-known rating agencies operating in India.  The table below will give an idea about different ratings.

RATINGS DEFINITION OF RATINGS
AAA Highest Degree of Safety
AA High Degree of Safety
A Adequate Degree of Safety
BBB Moderate Degree of Safety
BB Moderate Risk of Default
B High Risk of Default
C Very High Risk of Default
D Already in Default

 

BASIC COMPARISON BETWEEN CORPORATE BOND AND FIXED DEPOSIT

SR.  NO.   CORPORATE BOND FIXED DEPOSIT
1 FIXED INTEREST YES YES
2 RATED YES NO
3 SECURED YES NO
4 LIQUIDITY MORE LIQUID LESS LIQUID
5 CHARGES IF INVESTMENT BROKEN BEFORE MATURITY NIL YES
6 RETURNS HIGHER LOWER

 

WHY INVEST IN BONDS 

  • STEADY INTEREST INCOME: Fixed Income Securities also known as Bonds, provide steady interest income to investors throughout the life of the bond.
  • DIVERSIFICATION OF RISK: Fixed Income Securities can also reduce the overall risk in an investment portfolio.
  • LOW VOLATILITY: Bonds carry very low volatility as compared to the prices of equity or mutual fund.
  • SAFETY OR PRINCIPLE PROTECTION: Investors benefit by preserving and increasing their invested capital.
  • DIVERSIFICATION OF PORTFOLIO: Bonds enable efficient portfolio diversification and thus assist in portfolio risk mitigation.
  • SECURED INVESTMENT: There is high priority claim to asset, as some type of bonds are secured bonds. Investors in bonds have a higher priority over common and preferred stockholders.
  • REDUCED CREDIT RISK: The credit risk is almost negligible, as the bonds are rated by rating agencies.

WHY NO GROWTH OF CORPORATE BOND IN INDIA?

  • Big investment due to high Face Value (mostly Rs.10,00,000/-)
  • Low Investor Base: means a smaller number of retail investors
  • Low Liquidity: Though the liquidity is high compared to fixed deposit, but once the bond becomes old enough in the market, the liquidity dries up
  • Lack of Financial Literacy or Very little knowledge of corporate bonds among investors
  • Underdeveloped functioning of corporate bond market

 INPUTS FOR DEVELOPMENT OF CORPORATE BOND MARKET IN INDIA

If the retail investors need to participate in the corporate bond market, the authority should think of affordability of the retail investor.  Hence, I feel that, if the face value of a bond is reduced to Rs.1,00,000/- from Rs.10,00,000/-, then it will be in reach of a retail investors investment goal.

The authority should think of introducing a special Investor grievance group, which should cater to only issues faced by retail investors.

As we have mutualfundsahihai.com, there should also be some educational website (suggested name- corporatebondhaina.com) for bonds as well.  Retail investors can get some basic knowledge of how the market functions, who is the regulator, whom to approach in case of any issue, etc.

Reserve Bank of India (RBI) have refinance scheme for Banks to have funds requirement of a bank.  Similarly, the regulator should think of having some intermediary or an institution who can fund the retail investors in case they are in need of funds either by giving refinance or by buying their bonds at the prevailing market rate.  This will improve the liquidity and also give confidence to the retail investors to enter the unknown territory of corporate bonds market.

As the market sometimes moves up and down due to unknown factors to the retail investors.  This related information or news (financial or non-financial) should be made available at real time on the website (corporatebondhaina.com).  This information should be made available free of cost to the retail investors.

As we have indices of equities, there is no bond index, which enables real time monitoring of the corporate bond market in India.  Such an Index / Indices will bring transparency in rates at which the market is prevailing for all the bonds.

– By Prasad Kelkar 

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