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SEBI

Investorguideforcorporate bondsmarket

Issued in the interest of investors by Securities and Exchange Board of India (SEBI)

Whatarecorporatebonds?
Corporatebondsarenothingbutdebtinstrumentsissuedbya corporation, the holder of which receives interest from the corporationperiodicallyforafixedperiodoftimeandgetsback the principal along with the interest due at the end of the maturityperiod. E.g. Considering that you hold a 10% 5year corporate bond issued by XYZ Co. with Face Value Rs. 100 and interest is paid annually: XYZCo.will PayyouRs.10everyyearfor5years Redeem face value of the bond i.e. Rs.100 + Rs. 10 accruedinterestattheendof5years.

Seemssimilartoabankfixeddeposit???Youmayfindacorporatebondsimilartoafixeddepositinabankora postofficeschemeoranysuchfixedreturninstrument.However,everytypeofinvestmentisdifferentinitsown wayandhasitsownfeatures,advantagesanddisadvantages.

Isntitsameasadebenture??InIndia,thetermscorporatebondsanddebenturesareinterchangeablyused. Though different countries have different interpretations of both the terms corporate bonds and debentures, ourCompaniesAct(Section2(12))identifiesbothassame.

WhocanissuecorporatebondsinIndia?
InIndia,bothpublicandprivatecompaniescanissuecorporatebonds.AcompanyincorporatedinIndia,butpart ofamultinationalgroup,canalsoissuecorporatebonds.However,acompanyincorporatedoutsideIndiacannot issuecorporatebondsinIndia.AstatutorycorporationlikeLICcanalsoissuecorporatebonds.

Benefitsofinvestingincorporatebonds
Why should you invest in corporate bonds??? If you are looking for an investment that generates fixed income periodically,corporatebondsmaybeanidealinvestmentforyou.Itnormallyoffersyouahigherrateofinterestas comparedtofixeddepositsorpostalsavingsorsimilarinvestments.Ifyourbondsarelisted,youcanalsosellitin the secondary market before its maturity. While a bond is usually not designed for capital appreciation; a listed bondmayalsoearnyoucapitalappreciationi.e.youcansellyourbondatapricehigherthanyourcostpriceinthe market.

ModelofCashflow
Whenyoubuybonds

Bonds

You (Investor)

Company (Issuer)

Money(Investment)

DuringtheperiodyouholdtheBond Interest

periodically
You (Investor) Company (Issuer)

Onmaturitydate

Principal+ Interestaccrued

You (Investor)

Company (Issuer)

Bonds

Shares?? Bonds??

Deposits??

Corporatebondsv/sotherformsofinvestment
Corporatebondsv/sequityshares

If you hold an equity share of Ifyouholdacorporatebondof XYZCo. XYZCo.


1. You are part owner of the company 2. Youmayenjoyvotingrights. 1. YouarealendertoXYZCo. 2. You do not enjoy voting rights.

Whatisyourrelationto thecompany?

What will you earn Yourreturnswouldbeintheformof Yourreturnswouldbeintheformof fromyourinvestment? 1. InterestpaidbyXYZCo. 1. DividendpaidbyXYZCo. 2. Capital appreciation (increase in price of your share) How risky investment? is 2. You may earn capital appreciation if your corporatebondsarelisted.

your As a thumb rule, equity shares are As a thumb rule, corporate bonds consideredtobetheriskiestformof arelessriskythanequityshares. investment. However,corporatebondsalsohave theirownsetofrisks. All the risks that you may face are detailedlaterinthisdocument.

How liquid is your In case of equity shares listed on a investment? stock exchange, most are easily tradable and hence you can easily (Ifyouwanttosellyour sellyourshare. share/bond at any pointoftime,howeasily In case of unlisted shares / illiquid canitbedone?) shares,youmayfindsomedifficulty

If your corporate bond is listed, you will find it easier to sell your bond before maturity date. However, in India, corporate bonds are not as liquidasshares.

However, if your corporate bond is and cost involved in selling your notlisted,youwillfinditdifficultto share. sell your bonds before maturity date.

What will happen to You will get face value of your You will get preference over the your investment if the investmentbackonlyafterallother share holders of the company in

companyclosesdown?

stakeholders are paid back their getting back face value of your money. investment. However,yourdueswillbepaidonly afterstatutorydues(liketaxunpaid, etc.)arecleared.

Corporatebondsv/sfixeddepositinabank

If you hold a fixed deposit If you hold a corporate inaBank bondofXYZCo.

Whatwillyouearnfromyour A fixed amount of interest Fixed or varying amount investment? periodicallyfromthebank depending on whether interest rateisfixedorfloating. (Refer to fixed/floating rate of interestlaterinthisdocument) Is your guaranteed? investment Yourdepositisguaranteedupto a maximum of Rs. 1 lakh by Deposit Insurance and Credit Guarantee Corporation of India (DICGC) for both principal and interestamountearnedbyyou. Your investment is not guaranteed by Government of India or RBI or any Government sponsoredagencies.

Howtoinvestincorporatebonds? Howcanyouinvestinsuchbonds???Thecompanywhichisplanningtoraisefundsthroughcorporatebondswill offerapublicissueoraprivateplacement.Aprivateplacementisusuallymadetoinstitutionalinvestorsandnotto retailinvestors.


Apublicissuemeansanofferwillbemadetothepublicingeneraltosubscribetothebonds.Inapublicissue,the company has to issue a prospectus before issuing the bonds. A prospectus is nothing but a document containing detailsaboutthecompanyandthebondstobeissued.Afterthepublicissue,thesebondsarelistedonarecognized stockexchangeinIndia.Hencesuchtypesofbondsarecalledlistedbonds.

Whatareprimary/secondarymarkets?? Incaseoflistedbonds,aninvestorcanbuythebondsthrough2avenues: Throughthepublicofferingbythecompany Throughtheexchange

The public offering by the company is referred to as primary market and the trading of the shares subsequently through the exchange is called secondary market. You can buy bonds through either of these markets. If you buy the bonds through the public offering, you will be buying the bonds directly from the companyandifyoubuythebondsthroughthesecondarymarket,youwillbebuyingthebondsnotfromthe company,butfromsellerswhowishestosellthebondsheldbythem. Whenyoubuythebondsthroughapublicoffering,youusuallybuyitatthefacevalueofthebond.However, theissuermayalsoissuethebondatapremiumoradiscount.Whenyoubuythebondsfromtheexchange, youhavetopaythemarketprice,whichmaybehigherorlowerthanthefacevalue.

TechnicalTermssimplified
How do I understand the all the technicalities involved??? An issue of Corporate Bonds often involves various technical terms which any investor needs to understand before investing in the corporate bonds market.Thisdocumentoffersexplanationforcommontermsusedinanyissueofcorporatebondsalongwith examplestosimplifytheconceptsinvolved.

Note:Forsimplification,facevalueofthecorporatebondinallexampleshenceforthwillbetakenasRs. 100.

ListofTechnicaltermswhichareexplainedinthenextfewpages

Fixed/FloatingInterestrate:
Acorporatebondmayofferafixedorfloatingrateofinterestandaccordinglyyoumayearnafixedorvarying amountofinterestperiodically. Afixedratebondwillpayyouafixedamountperiodicallyaspertheinterestratesetoutwhenthebondswere issued. This interest is determined as a % of the Face Value of the bond. Such fixed interest payments are sometimesalsocalledcouponpayments. Afloatingratebondhasitsinterestratepeggedtoabenchmarkrateie.(Benchmarkrate)+/(some%).The benchmarkratemaybeGovernmentbond/MIBOR.Asthebenchmarkratechanges,theinterestrateonthe bondwillvaryaccordingly.Hence,afloatingratebondisconsideredtoberelativelyriskysinceyourreturnis dependentonthemovementofthebenchmarkrate.

Whatdoesitmean?

Example
Fixedrateofinterest: A10%5yearcorporatebondwithinterestpaidsemiannually willearnyouafixedamountofRs.5attheendofevery sixmonthsfor5years. Floatingrateofinterest A Corporate bond offering 10 yr government bond/MIBOR + 2%withinterestpaidsemiannually will earn you varying amount of interest depending upon the prevailing MIBOR rate. If prevailing MIBOR rate is say 8% then interest rate on your bond will be 8+2=10%

Whyisitimportantforyou?
Ifyouwishtoreceiveafixedamount periodically,afixedratebondis advisable. However,afixedinterestratebond mayearnyoulessthanafloatingrate bondduetolesserriskinvolved. Ifyouplantoinvestinafloatingrate abond,rememberthatyoureturn willdependonthemovementofyour benchmarkratewhichmaymovein eitherdirectionsubstantially.

Periodicityofinterestpayments

Whatdoesitmean?

An investor in corporate bonds receives his interest payments periodically. The interest may be received yearlyorhalfyearlyorquarterlyorevenmonthly dependingupontheperiodsetatthetimeofissue.The interestpaymentdatesareusuallyspecifiedintheprospectus. Onthematuritydate,theissuerpaysbacktheinvestorfacevalueofthebondsheldbyhimalongwiththe interestaccruedonthesame. Interestpaymentsaresometimesclassifiedascumulativeornoncumulative. Incaseofcumulativeinterestrepayments,iftheissuerisunabletopaytheinvestortheinterestonthedue date, the interest gets accumulated and can be paid on the next scheduled payment date. This clause is beneficial to the issuer since he can adjust his cash flows accordingly. However it is not beneficial to the investorsincehelosesthetimevalueofmoney. However, a cumulative interest repayment is always a better option for the investor as compared a non cumulativebondsinceincaseofnoncumulativebonds;theinterestgetsforfeited,ifnotpaidbytheissueron theduedate.

Example

Whyisitimportantforyou?
Before investing, ensure that the payment periodicity suits your investment requirements. Also check whether the interest payments are cumulative or noncumulative since it canimpactyourcashflowsinfuture.

A 12% 10year cumulative corporate bond with interestpaidsemiannually. willearnyouafixedamountofRs.6attheend ofeverysixmonthsfor10years. Incasetheissuerisnotabletopaytheinterest onthescheduleddate,hecanpayRs.12(Rs.6of the earlier halfyear + Rs.6 of current half year) onthenextscheduledpaymentdate.

Maturitydate

Whatdoesitmean?

Maturitydateisthedateonwhichthebondmaturesi.e.issuerrepaysthefacevalueofthebondalong with the accrued interest to the investor and dissolves himself of all the obligations attached to the bond.Theissuerisboundtobuybackthebondonthematuritydate. Thematuritydatedetermineswhetherthebondislongterm,shorttermormediumterm.Thematurity dateisusuallymentionedexplicitlyintheprospectus. However,somebondshavecertainoptions(callorputoptions)whichmayallowtheissuertobuyback thebondsbeforetheduedateortheholdertosellthebondsbacktotheissuerbeforetheduedate. Thismayreducethetermofthebondandhenceitisessentialthatyouanalysetheeffectofexercising ofsuchoptionsonyourcashflowsbeforebuyingsuchbonds.

Example
A 12% 10 year corporate bond with interest paid quarterlyissuedon2ndJanuary,2010 Hasamaturityof10yearsandwillmatureon 1stJanuary2020. On 1st January, 2020, the investor will receive face value of his investment along with accruedinterest.

Whyisitimportantforyou?
The maturity date will help you ascertainwhichtypeofbondissuitable toyourinvestmenthorizon. In case of unlisted bonds, you would notbeabletotradetheminthemarket and hence your funds would be locked uptillmaturitydate. You should look out for call options or put options in the prospectus since it will impact your cash flows if such bondsareexercisedinfuture. Theoptionwillalsoimpactthepriceof thebondatthetimeofissueandduring the trading period of the bond. (For detailsrefer tocall/putoptionslater in thisdocument)

Secured/Unsecuredbonds

Whatdoesitmean?

If the company in whose bonds you have invested is wound up (closes down), its important for you to know where you stand when the company repays its debts. The order in which the Company repays its debtsdependsupontherankingofthebondsbasedonthesecurity Bondsareeithersecuredagainstassetsorunsecured.Ifthebondsaresecured,intheeventofwindingup ofthecompany,itwouldsellofftheassetsagainstwhichthebondsweresecuredandrepaytheinvestor. However,allsecuredassetsdonothavethesameranking. RANKING Statutoryandtaxdues Securedbonds(senior) Securedbonds(subordinated) Unsecuredbonds Preferenceshares Equityshares
Note:Onecannotinvestinstatutory/taxdues.Thediagramisonlyforrepresentativepurpose

Whenthecompanyrepaysitsassets,ithastofollowthefollowingorderinrepaymentofitsdues: 1. Statutoryandtaxdues 2. Securedbonds(senior) 3. Securedbonds(subordinated) 4. Unsecuredbonds 5. Preferenceshares 6. Equityshares

RETURNS

You,asabondholder,willberepaidyourprincipalamountbeforetheshareholdersbutafterpaymentof pendingstatutorydues.Ifyouholdseniorsecuredbonds,youwillberankedhigherthantheholdersof subordinatedsecuredbondsandunsecuredbondsinrepaymentofduesincaseofclosureofthecompany.

Example
If you hold subordinated bonds of a company XYZandthecompanybecomesinsolvent: You will be repaid the principal and interest amount due only after the statutory and senior secured bondholders are repaid. Hence, you may evengetbackonlypartofyourmoneyif the amount left over is less than what is duetoyou. You will be repaid to the extent of amount realized of the assets against whichthebondwassecured. Iftheamountrealizedonsaleofassetsis less than the value of the dues against the bonds, you will only get prorata repayment and not the full value of the duesagainstyourname.

Whyisitimportantforyou?
Before you purchase a bond, please read the prospectuscarefullytounderstand Arethebondssecuredorunsecured? Ifsecured,whatistherankingwithrespect tootherstakeholders? Thereturnsofthebondwilldependonthesecurity and its ranking among other stakeholders. An unsecured bond will pay you more interest than a secured bond to compensate for the higher risk involved. Similarly, as a rule of thumb, higher the rankingofthebond,lowerwillbeitsreturn. Before investing in any bond, assess both the risks andthereturnsassociatedwiththebondandinvest accordingly.

Capacityofthefirmtorepay
Whatdoesitmean?
Whenyouinvestincorporatebonds,youneedtoensurethecompanyisinapositiontorepayyour principalandtheinterestduetoyou.Hence,youneedtoanalyzethecompanywellbeforeinvestingin itsbonds. Howcanthefinancialcapacitybechecked?? Youcananalyzethehealth ofthecompanybychecking itsbusinessmodel,itsfinancials,byemployingratios,bymeetingitsmanagementandinseveralother ways.Themostcommonwayofanalyzingtheabilityofacompanytopayitsdebtsisbyanalyzingits financialstatements.You need notbe bogged downbythehugedatathatisprovidedin theannual reports.Someratioswhicharegivenbelowcanbeusedtodotheanalysis.Theseratiosaresimpleto understandandsufficienttohaveafairideaofthecapacityofthecompanytorepayyourdues. However,alongwiththeratios,checkthematuritypatternoftheexistingloansofthecompanyand verifywhetherthereisasignificantamountofdebtmaturingsoonandwhichmayhavetoberolled over.Inaddition,verifywhetherthecompanyhas beena defaulterin thepastorhasrolledoverits debtorhasbreacheditsloanagreementorwhetherthereare/wereanylawsuitsagainstthecompany.

Ratios

Formula

Whatdoesitsignify?

Example

1 Interest Coverage Ratio

EBIDTA/ Net This ratio is used to verify E.g.:Ifacompanys: whether the companys InterestExpenses operations generate enough 1. EBIDTA = Rs. 300 croreand OR earnings to sustain its interest 2. Net interest EBIT/Net Interest payments. expenses = Rs. 30 Expenses Hence, If interest coverage ratio crore, is high, it means the company is in a good position to make your Then the interest rate coverage ratio is 10 i.e. interestpayments. the company has earnings 5 times larger While investing in any company, than its interest gothrough thecompanysprofit payments. and loss statement and by calculating its interest coverage ratio,makesurethatitsearnings are comfortably higher than its interestpayments. Totaldebt/Total It represents how leveraged the E.g.Ifacompanys:

2. Debtto

EquityRatio

Equity Where Totalequity= Shareholders capital+Reserves andSurplus Fortotaldebt,you caneitherusetotal liabilitiesoronly longtermdebt.

company is i.e. how much has Total debt= Rs. 100 the company borrowed visvis crore itsownmoney. Total equity= Rs.150 There is no ideal debttoequity crore ratio against which a company can be measured. A high debt It debttoequity ratio is toequity ratio generally means 1.5 that a company has been aggressiveinfinancingitsgrowth with debt. Before investing n such company bonds make sure the companys financial position is such that it can sustain such highamountofdebt. All these ratios give a fair clue about the general financial performance of the company and will help you analyze whether the company is strong enough to meets its financial obligations E.g. If a Companys net profit ratio (Net profit/Sales) has increased from 15% to 18% , its market share has increased, its sales/ assets ratio has increasedfrom2to2.5, etc.; It means overall the company is performing wellandhencewillbein a better position to fulfill its financial obligations than a company whose performanceisdismal.

3 Otherratios

Ratios/ Parameters like Profitability, cashflow,changein market share, increaseinrevenue, assets employed, etc. over the last fewyears

Bonds

Convertible bonds

Shares

Convertible/Nonconvertiblebonds
Whatdoesitmean? Bondswhichcanbeconvertedintoequitysharesatalaterdatearecalledconvertiblebonds.Suchconversioncan occuratapricepredeterminedatthetimeofissueofbondorattheprevailingmarketprice.Onthesamelines, bondswhichcannotbeconvertedintoequitysharesarecallednonconvertiblebonds. Isitanequityshareorabond??Convertiblebondsareinfacthybridsecuritiesi.e.theycarrythefeaturesofboth equityanddebt.Tilltheinvestorholdsthebond,hereceivesinterestperiodically.However,onceitisconverted intoequityshares,theinvestorenjoysbenefitsasanequityshareholder.Thisgivesthebondholderbothafixed incomeinvestmentwithcouponpaymentsaswellasthepotentialtobenefitfromanincreaseinthecompanys shareprice. Sinceconvertiblebondscarrytheadditionaloptionofconversionintoequityshare,theinterestrateisusuallyless ascomparedtoanonconvertiblebond. Somebondsarecompulsorilyconvertibleintoequitysharesafteraparticularperiodoronaparticulardate.Such bondsarecalledcompulsorilyconvertiblebonds.

Example
If you hold a 6% bond, interest payable annually, of XYZCo.convertibleinto10sharesofXYZCoanytime after3yearsthen: YouwillgetRs.6everyyearforthefirst3years You can convert it into 10 equity shares at any point of time after 3 years at the prevailing marketprice Once you convert the bond into equity shares, youwilllosethefixedinterestof6%,butenjoy benefitsofequityshares.

Whyisitimportantforyou?
If you buy convertible bonds, ensure that you understand the conditions attached with it relating to the price of conversion, number of shares, the time period after which conversion canbemade,etc. In addition, check whether the bonds are compulsorily convertible & the conditions attachedtoit. Before investing in such bonds, analyze the returns that you would be earning from such bonds&ensurethattheymatchwithyourreturn requirements.

Put&CallOptions
Whatdoesitmean? Somebondshaveembeddedoptionswhicheitherallowtheissuertobuybackthebondsbeforethematurity or theholderofthebondstosellthebondstotheissuerbeforethematurity.Suchoptionsareexplicitlystatedinthe offerdocumentatthetimeoftheissueofthebonds. Whatarecallablebonds??Bondswhichgivetheissuerrighttobuyback thebondsbeforeitsmaturityarecalled callablebonds.Callablebondsusuallycomewithaninitiallockinperiod.Sinceinvestinginsuchbondsexposesthe investortotheadditionalriskofbuybacktheyusuallyofferahigherrateofinterestascomparedtobondswithout suchoptions. Whatareputtablebonds??Bondswhichgivetheinvestortherighttosellthebondsbacktotheissuerbeforethe maturityofthebondarecalledputtablebonds.Sincesuchbondsgivetheinvestorarighttosellbeforematurity, theyusuallyofferalowerrateofinterestascomparedtobondswithoutsuchoptions.

Example
If you hold a 8% bond, interest payable annually, of XYZ Co. with a put option to the investor to sell the bondsatpartotheissueranytimeafter3yearsfrom thedateofissue,then: Till end of the 3rd year from the date of issue, you cannot sell the bond back to the issuer (However,ifitisalistedbond,youcansellitin themarketevenduringthe1st3years) After3yearsfromthedateofissue,youcansell backthebondtotheissueratRs.100perbond anytimetillthematurity.

Whyisitimportantforyou?
Call or put options on your bonds may alter yourcashflowssignificantlyinfuture. Before buying callable bonds, ensure that you understandtheprepaymentriskassociatedwith thebond. Remember that a puttable bond may cost you more than a normal bond due to the option attached to it. Hence, weigh the benefit you derivefromtheoptionwiththecostassociated withitandbuyitonlyifyoufeelitsworththe investment.

Risksinvolvedininvestingincorporatebonds
Thoughcorporatebondsarelessriskyascomparedtoinvestmentssuchasshares,theyhavetheirown risks.Someoftherisksthatyouwillbefacedwithifyouinvestinacorporatebondarelistedbelow: