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About Corporate Bonds
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, generally semiannually. 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.
About Government Bonds
A government bond is a bond issued by a national government, generally with a promise to pay periodic interest payments and to repay the face value on the maturity date. Government bonds are usually denominated in the country’s own currency.Government bonds are sometimes referred to as “‘sovereign bonds“‘.
Need for Corporate Bonds
One of the announcements in the Budget 2005-06 was to appoint a high level expert committee on corporate bonds and securitization to look into the legal, regulatory, tax and market design issues in the development of corporate bond market.
A committee was formed under the Chairmanship of Dr. R.H. Patil to look into the factors inhibiting the development of an active debt market and recommend policy actions necessary to develop an appropriate market infrastructure for the growth of an active corporate bond market.
A few of the recommendations for the development of an active secondary market for corporate bonds are:
– Establish a system to capture all information related to trading in corporate bonds as accurately and as close to execution as possible and disseminate it to the market in real time.
– Clearing and settlement of transactions in this market must adhere to the IOSCO standards.
– Based on increase of awareness amongst the participants to introduce online order matching system.
Benefits of Corporate Bonds
– Issue of Corporate Bonds is beneficial for Infrastructure Companies as they require Capital for a long period as compared to other sectors.
– Corporate Bonds help in reducing the overall cost of borrowings as compared to cost of borrowings from the Banks.
– Long Term Capital can be effectively raised through issue of Bonds.
– The rating of Bonds helps the investor to take an informed decision.
– Rate of Interest is higher as compared to Bank Deposits.
– In case of Listed Bonds there is Liquidity of Investment and Capital appreciation.
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.