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If you are planning to invest in fixed-income securities
then you might want to look up for corporate bonds, which is considered as a
last safe investment option. Due to the financial crisis, many fixed-income
securities’ yield has a decline, which left only corporate bonds where we can
turn to. It is because of the appealing interest rates which make them one of
the best investment options for long-term. But, even corporate bonds have their
own advantages and disadvantages.
In order to understand this, we would have to go through different aspects such
as returns, liquidity, and risks among others.
Corporate Bonds – Advantages & Disadvantages
Returns
Unlike government bonds and treasury bills, corporate bonds are quite capable of
providing strong returns. Thus, people tend to opt for corporate bonds instead
of government bonds which have repeatedly plunged to new record lows. Most
investors who have low-risk tolerance prefer to choose to invest in corporate
bonds instead of direct equity or equity mutual fund in the stock market.
But, you gotta be aware of fluctuation in interest rates as well. If the
interest rate rises, the bond prices fall. If the interest rate rises, the value
of bonds which are already issued will decrease. But, the opposite can also
happen too. In this case, the decrease in interest rate will increase the value
of the already issued bond.
Note: The fluctuation in interest rates is caused by the interest rate decisions
taken by RBI committee who handles the monetary policies. To get updated on
interest rate decisions and other economic indicators, you should follow the
live economic calendar to track major and minor economic and financial
events/performances.
Widespread Options
Corporate bonds have varieties such as short-term bonds, medium-term bonds, and
long-term bonds. Beyond this, corporate bonds do offer many coupon structures
and the interest rates for bonds with floating coupon rates are usually based on
a benchmark such as Consumer Price Index (CPI). CPI is a quite important
benchmark, which explains why India adopted CPI to measure inflation.
But, don’t fall for high-interest rates or coupon structures. Sometimes, many
corporate bond issuers give high-bond yields intentionally to compensate the
risk of default. In fact, the credit risk and default risk happens a lot in
corporate bonds. There is also a risk for the issuer to go out of business and
will not be able to stand up to his obligations of paying timely interests and
principal amount.
Liquidity
If we leave government bond, then the corporate bonds along with other
fixed-income securities have liquidity risk. Corporate bonds trade in the
secondary market. Thus, it is difficult to exit the position and to get current
pricing. The limited secondary market makes it difficult to sell the bond. But,
if the bond has risen in value, one can get benefits from selling bonds or
buying after a price decline.
One thing is clear; the corporate bonds also have drawbacks. So, it would be
smart to decide whether you should invest in corporate bonds or not.
Nevertheless, if you have any query or would like to add something then doesn’t
forget to mention in the comment section below.
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