Learn with ETMarkets: What are corporate bonds & how they work

A corporate bond is a bond issued by a corporation to raise capital from the investors in the market to fund a variety of ongoing or potential projects, operational activities, expand the business, or for a variety of other reasons.

A Corporate bond in simple terms is a debt commitment for the issuer. A corporation that issues bonds makes a legal commitment to a bondholder in writing to pay certain interest on the principal at predefined intervals that can be either monthly, quarterly, half-yearly, or yearly.

Working of corporate bonds

To understand how corporate bonds work better let us compare corporate bonds with stocks.

If you buy a common stock share in a company, you own equity in the company. You become eligible to receive dividends (profits) declared by the company at different intervals and the right to take part in some company’s decisions.

On the other hand, when you buy a corporate bond, you do not get equity in the company. You become eligible to receive only a fixed rate of interest at varied intervals and a return of principal at maturity no matter how profitable the company becomes or how high the price of the stock climbs.

But if the company faces financial difficulties or declares bankruptcy, the bondholder will be the first to receive the due payments upon liquidation of the company’s assets.

The company issuing the bond is legally obliged to make timely payment of interest and the principal to the bondholders. In the condition of bankruptcy, bondholders get priority in claims on the company’s assets over shareholders.

Why invest in a corporate bond?
Corporate bonds can be an excellent choice to earn predictable income at a predefined interval while reducing the risk of capital losses. Also, corporate bonds in comparison to fixed deposits offer better returns, liquidity, and portfolio diversification.

Key advantages of buying corporate bonds
• The fixed and periodic returns in corporate bonds help you generate an additional source of income
• Compared to interest in FDs (3.26 % and 5.30%), the return in corporate bonds ranges between 7 to 14% annually
• Corporate bonds help you diversify the portfolio that reduces risks, help you improve your long-term portfolio performance, and smooths out returns.
• Your investment in corporate bonds is at a lower risk as compared to your investment in stocks.
• They can also provide you the benefit of capital gains

How to buy corporate bonds in India?
Buying corporate bonds today is free from hassle. In the primary market, you can buy corporate bonds through a broker, brokerage firm, bond trader, or bank. A few of the corporate bonds are traded also over the counter market. You can alternatively choose to buy corporate bonds online. You need to have a DEMAT account, and a trading account created on online bond platforms like bondsIndia.com in India.

What are the risks with corporate bonds?
Along with rewards, corporate bonds also carry certain risks. Consider the below listed key risks associated with corporate bonds to avoid any kind of disappointment. Key risks:

• Credit risk/default risk
• Call risk
• Interest /inflation risk

Conclusion:
Corporate bonds are thus an excellent choice for investors who are looking for a relatively safe option, predictable returns, periodic income, and reduce risk of capital losses.