CORPORATE BONDS

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Corporate bonds are debt securities issued by private and public corporations. Companies issue corporate bonds to raise money for a variety of purposes, such as building a new plant, purchasing equipment, or growing the business. When one buys a corporate bond, one lends money to the "issuer," the company that issued the bond. In exchange, the company promises to return the money, also known as "principal," on a specified maturity date. Until that date, the company usually pays you a stated rate of interest, monthly, quarterly, semi annually, annually or at maturity. While a corporate bond gives an IOU from the company, it does not have an ownership interest in the issuing company, unlike when one purchases the company's equity stock.

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Yield
Yield is a critical concept in bond investing, because it is the tool used to measure the return of one bond against another. It enables one to make informed decisions about which bond to buy. In essence, yield is the rate of return on bond investment. However, it is not fixed, like a bond's stated interest rate. It changes to reflect the price movements in a bond caused by fluctuating interest rates. The following example illustrates how yield works.

  • You buy a bond, hold it for a year while interest rates are rising and then sell it.

  • You receive a lower price for the bond than you paid for it because, no one would otherwise accept your bond's now lower-than-market interest rate.

  • Although the buyer will receive the same amount of interest as you did and will also have the same amount of principal returned at maturity, the buyer's yield, or rate of return, will be higher than yours, because the buyer paid less for the bond.

  • Yield is commonly measured in two ways, current yield and yield to maturity.

Current yield
  • The current yield is the annual return on the amount paid for a bond, regardless of its maturity. If you buy a bond at par, the current yield equals its stated interest rate. Thus, the current yield on a par-value bond paying 6% is 6%.

  • However, if the market price of the bond is more or less than par, the current yield will be different. For example, if you buy a Rs. 1,000 bond with a 6% stated interest rate at Rs. 900, your current yield would be 6.67% (Rs. 1,000 x .06/Rs.900).

Yield to maturity
It tells the total return you will receive if you hold a bond until maturity. It also enables you to compare bonds with different maturities and coupons. Yield to maturity includes all your interest plus any capital gain you will realize (if you purchase the bond below par) or minus any capital loss you will suffer (if you purchase the bond above par).

Valuation of Corporate Bonds
Corporate bonds tend to rise in value when interest rates fall, and they fall in value when interest rates rise. Usually, the longer the maturity, the greater is the degree of price volatility. By holding a bond until maturity, one may be less concerned about these price fluctuations (which are known as interest-rate risk, or market risk), because one will receive the par, or face, value of the bond at maturity. The inverse relationship between bonds and interest rates—that is, the fact that bonds are worth less when interest rates rise and vice versa can be explained as follows:
  • When interest rates rise, new issues come to market with higher yields than older securities, making those older ones worth less. Hence, their prices go down.

  • When interest rates decline, new bond issues come to market with lower yields than older securities, making those older, higher-yielding ones worth more. Hence, their prices go up.

  • As a result, if one sells a bond before maturity, it may be worth more or less than it was paid for.

Ratings
One of the important factors to be kept in mind while purchasing a corporate bond is the credit rating of the issuer of the bond. By looking into the credit rating of the issuer, one can have a view on the credibility of the issuer and the risk associated with investing into the bonds.
The rating scale issued by CRISIL is appended herewith for reference
Rating Description
CRISIL AAA (Highest Safety) Instruments with this rating are considered to have the highest degree of safety regarding timely servicing of financial obligations. Such instruments carry lowest credit risk.
CRISIL AA (High Safety) Instruments with this rating are considered to have high degree of safety regarding timely servicing of financial obligations. Such instruments carry very low credit risk.
CRISIL A (Adequate Safety) Instruments with this rating are considered to have adequate degree of safety regarding timely servicing of financial obligations. Such instruments carry low credit risk.
CRISIL BBB (Moderate Safety) Instruments with this rating are considered to have moderate degree of safety regarding timely servicing of financial obligations. Such instruments carry moderate credit risk.
CRISIL BB (Moderate Risk) Instruments with this rating are considered to have moderate risk of default regarding timely servicing of financial obligations.
CRISIL B (High Risk) Instruments with this rating are considered to have high risk of default regarding timely servicing of financial obligations.
CRISIL C (Very High Risk) Instruments with this rating are considered to have very high risk of default regarding timely servicing of financial obligations.
CRISIL D (Default) Instruments with this rating are in default or are expected to be in default soon.

  • CRISIL may apply '+' (plus) or '-' (minus) signs for ratings from 'CRISIL AA' to 'CRISIL C' to reflect comparative standing within the category.

  • CRISIL may assign rating outlooks for ratings from 'CRISIL AAA' to 'CRISIL B'. Ratings on Rating Watch will not carry outlooks. A rating outlook indicates the direction in which a rating may move over a medium-term horizon of one to two years. A rating outlook can be 'Positive', 'Stable', or 'Negative'. A 'Positive' or 'Negative' rating outlook is not necessarily a precursor of a rating change. CRISIL may place an outstanding rating on Rating Watch if the issuer announces a merger or acquisition, or de-merger of some business that may impact the credit profile of the rated debt instrument. Ratings may also be placed on watch if the issuer’s credit profile is impacted on account of an action by regulators, or when the impact of specific events on the credit profile cannot be accurately assessed at the point when they occur, and additional information may be necessary for CRISIL to fully ascertain the creditworthiness of the rated instrument. CRISIL may place a rating on watch, with positive, negative or developing implications. A listing under rating watch does not imply that a rating will necessarily change, nor is it a prerequisite for rating change.

  • A suffix of 'r' indicates investments carrying non-credit risk.The 'r' suffix indicates that payments on the rated instrument have significant risks other than credit risk. The terms of the instrument specify that the payments to investors will not be fixed, and could be linked to one or more external variables such as commodity prices, equity indices, or foreign exchange rates. This could result in variability in payments, including possible material loss of principal, because of adverse movement in value of the external variables. The risk of such adverse movement in price/value is not addressed by the rating.

  • CRISIL may assign a rating of 'NM' (Not Meaningful) to instruments that have factors present in them, which render the outstanding rating meaningless. These include reorganisation or liquidation of the issuer, the obligation being under dispute in a court of law or before a statutory authority.

  • A prefix of 'PP-MLD' indicates that the instrument is a principal-protected market-linked debenture. The terms of such instruments indicate that while the issuer promises to pay back the face value/principal of the instrument, the coupon rates of these instruments will not be fixed, and could be linked to one or more external variables such as commodity prices, equity share prices, indices, or foreign exchange rates

  • A prefix of 'Provisional' indicates that the rating centrally factors in the completion of certain critical steps/documentation by the issuer for the instrument, without these the rating would either have been different or not assigned ab initio.