How to assess a bond offer?

With the Tata Capital’s issue of non-convertible debentures receiving an overwhelming response, the limelight is once again on corporate debts for retail investors, perhaps after a long break. The spread between 10-year corporate bond and government bond yields is fairly high. Trade volumes in the corporate debt segment of exchanges have increased from average 4,000 trades in August 2008 to 60,000 trades in January 2009.

With the equity markets providing little signs of a revival, retail investors have turned their interest to debt. But investors need to remember that debt instruments too come with a risk tag. The high coupon rate offered by bond issuers could well be the premium for bearing higher risks. Investors may have to assess corporate bond offers based on the fundamentals and credit standing of the company, asset-backing in case of an insolvency, the rate offered vis-À-vis other debt options and the flexibility to exit during the term of offer.

‘Investment grade’?


One key parameter to assess the investment grade for a bond is to look at the credit rating it has received from rating agencies. A bond with ICRA’s LAAA or LAA rating may suggest strong credit and low chances of default. But if you get to hold a one of LB/LC/LD grade, beware. You run a high risk and the odds may turn against you.

Rating agencies offer grades by classifying bond issues under low/average/high/very high risk category. Bonds above B grade, which carry average to low risk, are generally considered investment grade.

Public institutions that have fiduciary responsibilities invest only in bonds of very low risk, generally ones with AAA/AA rating. But your choice of investment should be based on your risk appetite. Higher the risk that you are willing to assume, higher the coupon you will see. In other words, the issuers of low grade bonds – the ones that carry higher than the average credit risks in a bind – generally come with higher coupon rates to grab investors’ interest.

If grades confuse you or you are not one to merely go by ratings, the offer document of the issuer would help.

First look at the profitability of the company and if there have been any past cases of default. Then verify if the bond is secured. If secured, in the step next, ascertain the value of collateral (asset) given and also see if there are other outstanding secured debts. If the company’s all secured borrowings are backed by just a single collateral then in case of a default, chances are you may just receive only a proportion of what the company actually owed you.

In a secured bond there is at least some prospect of recovery in case of a default and even that assurance is not there in unsecured bonds. The law, however, makes it mandatory that the debt issuing entity should create a redemption reserve at least for a part of the value of the outstanding amount.

Tata Capital’s NCD issue, the latest in the corporate bond segment, offered the company’s fixed assets and future receivables as security for the amount collected. The NCD holders will thus have a right on the particular asset on default in the promised repayment.

Eye on Returns


If you intend to hold the bond till maturity the coupon rate offered by the issuer is your return on the investment. But even in this, your yield might go higher/lower, based on where you deploy the interest receipts. If you invest the interest receipt in options that offer higher returns (more than the bond) your overall yield will go up, else vice-versa.

Tata’s NCD offer gave a cumulative option to the public where they can leave the interest to be re-invested with the company and the interest amounts too would be earning a 12 per cent return. In a scenario such as the current one where interest rates are going down and all asset classes are delivering negative returns, investors may be better-off locking into attractive rates, provided they are not in immediate need of cash flows.

In deep discount bonds (or Zero coupon bonds) your yield is the difference between the bond’s issue price and the price at which it is promised to be redeemed. The holders of Bhavishya Nirman bond of NABARD would have bought it at Rs 8,500, but during redemption after 10 years they will get Rs 20,000.

A return of Rs 20,000 on an investment of Rs 8,500 in 10 years connotes a compounded return of 8.93 per cent and this is your yield on investment.

With the regulator’s axe on interest rates, the corporate bond segments on the BSE and the NSE have been seeing sharp surge in volumes. Many investment grade bonds can be traded in the secondary market and you need not stay invested in them till maturity.

Check Payout options


Your bond’s value in the secondary market is a function of the issuer’s reliability and the coupon it offers is in relation to its peers and the government bond yield then. PFC and IDFC, both maturing in 2018, are trading in the market at significant price differences.

PFC that offers 11 per cent coupon traded at Rs 110.9 and IDFC that offered 8.95 per cent coupon traded at Rs 98.90 in the market on February 25.

So if you find a strong price rally in the market after allotment or wish to cash-out, you can sell it in the secondary market itself.

Alternatively, you can also avail the put option if given by the bond issuer.

Bond issuers generally give the holders the option of redemption much before the due date. Tata NCD has offered its holders the option of early redemption at the end of 36 months and 46 months while its term is 60 months. Holders can exercise this put option and get their money back. Similarly, if the issuer wishes to repay the holders ahead of the redemption date, he can avail of the call option and repay the holders.

But do remember that it is not mandatory for companies to either list in the exchanges for trading or give you a put option.

So do your homework to find out if the company proposes to get its bond listed and also if it’s offering you an early exit option. If not, ensure that the company is a safe option to lock your money over the medium or long term.