A company may need money for a variety of purposes. It may want to expand its business, build a new plant, buy machinery, buy new land to build a factory, or even purchase another company. One of the ways to raise money is to issue a corporate bond. Last year, as reported by Bloomberg, there was a spurt in bond issuances because companies were borrowing extra to build cash buffers to insulate themselves from financial pain caused by the pandemic.
When you buy a bond, you lend money to the company that issued the bond (issuer). In exchange, the company promises to return your money (principal) on a predetermined date (maturity date), and till it does so, it will pay you a specified rate of interest (coupon rate).
Say you invest Rs 5,000 in a 6-year bond, paying a coupon rate semi-annually of 5% per year.
Face Value: Rs 5,000. This is the amount you loaned to the company and it promises to return it on maturity.
Maturity: 6 years. This is the tenor of the bond. It is the length of time of the financial contract.
Coupon Rate: 5% per annum. The Coupon Rate is always tied to the bond’s Face Value. 5% of Rs 5,000 = Rs 250 per annum.
Since the payment is to be made semi-annually, you will receive 12 coupon payments of Rs 125 each (Rs 250 per annum). A bond is a debt obligation. The company makes a legal commitment to pay interest on the principal and to return the principal. Whether the company makes profits or incurs losses, or its stock price rises or falls, that is irrelevant to the terms and conditions. It still has to pay the interest rate promised and return the money on the specified date.
There are two ways to invest in corporate bonds
The first is the direct route. But there are many factors that go into selecting a bond. Rating agencies (CARE, ICRA, India Ratings, Brickworks and CRISIL) rate these bonds so that an investor can understand the risk associated with that company.
The more convenient option is to invest in a corporate bond fund (Mutual Fund). Such funds invest a minimum 80% of the corpus in AA+ and above rated bonds, which indicates high safety. These investments are diversified across companies and sectors.