Corporate Bond

Corporate Bond

Subject: Economy

Context: In FY22, the amount of money raised through public issuances of corporate bonds was just about 2 percent of the amount of money raised through private placement as per a deputy governor of the Reserve Bank of India (RBI)

Concept:

Corporate Bonds:

• Corporate Bonds are debt instruments that a private firm or company issues to raise money from the public. 
• People who invest in corporate bonds are called bondholders and lend money to the company by buying the issued corporate bonds.
• When the bondholders invest in the corporate bonds of a company, the company makes a legal commitment to provide regular interest payments on the principal amount based on the corporate bond rates. Furthermore, after maturity, the company has to pay back the principal amount to the bondholders. Corporate bond types offer numerous features but have to fulfill the basic legal obligations such as interest payments (not in the case of zero-coupon bonds) and the repayment of principal.

Types of Corporate Bonds

• Zero-coupon Bonds: 
  • These types of bonds do not pay regular interest to the bondholders but are available at a discount.
  • The only payment done is for repaying the principal amount at the time of maturity. However, bondholders have to pay taxes on the accrued interest value.
• Convertible Bonds: 
  • They are hybrid bonds that have the option to be converted to stocks based on the underlying asset of the bond.
  • Once the bonds are converted to regular shares, the bondholders become shareholders and the issuer is not liable to pay interest in the future.
• Floating Rate Bonds: 
  • Floating rate bonds have fluctuating interest rates and provide different interest payments to the bondholders every time.
  • The coupon rate is based on the prevailing interest rates in the market and the ability of the company to provide a certain interest to the bondholders.
• Fixed-Rate Bonds: 
  • Fixed-rate corporate bonds, also called vanilla bonds, pay the bondholders a predetermined amount as interest.
  • The coupon rate is fixed at the time of issuance of such bonds and does not change throughout the tenure of the corporate bonds.
• Investment Grade Bonds: 
  • Corporate bonds are classified based on their credit ratings. Investment-grade bonds are those corporate bonds that have a credit rating higher than BBB- and go up to the highest possible rating of AAA.
  •  Investment-grade bonds are issued by financially strong companies and have a negligible possibility of default on payments.
• Junk Corporate Bonds:
  • Junk bonds are a type of bond that carries a higher risk of default.
  • The issuer of such bonds may not have the adequate cash flow to pay regular interest or repay the principal amount to the bondholders at the time of maturity.
  • The bonds issued by financially struggling companies are termed junk bonds and generally have higher yields as it is only through a high yield that junk bonds can offset any risk of default.

Issuing of bonds:

• Public Issue-
  • When an issue / offer of securities is made to new investors for becoming part of shareholders’ family of the issuer, it is called a public issue.
  • Public issues can be further classified into
    • Initial Public Offer (IPO): When an unlisted company makes either a fresh issue of securities or offers its existing securities for sale or both for the first time to the public, it is called an IPO. This paves way for listing and trading of the issuer’s securities in the Stock Exchanges.
    • Follow on Public Offer (FPO): When an already listed company makes either a fresh issue of securities to the public or an offer for sale to the public, it is called a Follow on Public Offer (FPO).
• Private placement:
  • A private placement is the sale of securities to a relatively small number of select investors as a way of raising capital. Investors involved in private placements are usually large banks, mutual funds, insurance companies and pension funds.
  • A private placement is different from a public issue, in which securities are made available for sale on the open market to any type of investor.
  • Private placement of shares or convertible securities by listed issuer can be of two types:
    • Preferential allotment: When a listed issuer issues shares or convertible securities, to a selected group of persons as per SEBI guidelines, it is called a preferential allotment. The issuer is required to comply with various provisions which inter-alia include pricing, disclosures in the notice, lock-in etc., in addition to the requirements specified in the Companies Act.
    • Qualified Institutions Placement (QIP): When a listed issuer issues equity shares or securities convertible into equity shares to qualified institutions buyers only in terms of provisions as per SEBI guidelines, it is called a QIP.
• Rights Issue:
  • When an issue of securities is made by an issuer to its shareholders existing as on a particular date fixed by the issuer (i.e. record date), it is called a rights issue.
  • The rights are offered in a particular ratio to the number of securities held as on the record date.

• Bonus Issue:
  • When an issuer makes an issue of securities to its existing shareholders as on a record date, without any consideration from them, it is called a bonus issue.
  • The shares are issued out of the Company’s free reserve or share premium account in a particular ratio to the number of securities held on a record date.