Learn with ETMarkets: What are corporate bonds and how they work
A corporate bond in simple terms is a commitment of debt to the issuer. A company that issues bonds legally commits in writing to a bondholder to pay certain interest on the principal at predefined intervals which can be monthly, quarterly, semi-annually or annually.
Exploitation of corporate bonds
To better understand how corporate bonds work, let’s compare corporate bonds to stocks.
If you buy a common stock of a corporation, you own stock in the corporation. You become eligible to receive dividends (profits) declared by the company at different intervals and the right to participate in certain decisions of the company.
On the other hand, when you buy a corporate bond, you do not get a stake in the company. You become eligible to receive only a fixed rate of interest at varying intervals and return of principal at maturity, regardless of how profitable the business is or how much the stock price rises.
But if the company runs into financial difficulties or declares bankruptcy, the bondholder will be the first to receive the payments due when the assets of the company are liquidated.
The bond-issuing company is legally bound to pay interest and principal to the bondholders on time. In the event of bankruptcy, the bondholders obtain the priority of claims on the assets of the company compared to the shareholders.
Why invest in a corporate bond?
Corporate bonds can be an excellent choice for earning predictable income at a set interval while reducing the risk of capital loss. In addition, corporate bonds compared to term deposits offer better yields, liquidity and portfolio diversification.
Key Benefits of Buying Corporate Bonds
• Fixed, periodic corporate bond returns help you generate an additional source of income
• Relative to FD interest (3.26% and 5.30%), corporate bond yields range between 7 and 14% per year
• Corporate bonds help you diversify the portfolio, which reduces risk, helps you improve long-term portfolio performance and smooths returns.
• Your investment in corporate bonds is less risky than your investment in stocks.
• They can also make you benefit from capital gains
How to buy corporate bonds in India?
Buying corporate bonds today is hassle-free. In the primary market, you can buy corporate bonds through a broker, brokerage firm, bond trader, or bank. Some of the corporate bonds are also traded in the over-the-counter market. You can also choose to buy corporate bonds online. You must have a DEMAT account and a trading account set up on online bond platforms like bondsIndia.com in India.
What are the risks with corporate bonds?
In addition to rewards, corporate bonds also carry certain risks. Consider the main risks listed below associated with corporate bonds to avoid disappointment. Main risks:
• Credit risk/default risk
• Appeal risk
• Interest/inflation risk
Corporate bonds are therefore an excellent choice for investors seeking a relatively safe option, predictable returns, periodic income and reduced risk of capital loss.