When we seek to invest in bonds, we usually come across the two major types of bonds i.e. Government bonds and corporate bonds. Both of them contain a certain set of risks and have some benefits as investment instruments. Let’s find out which one is a better investment option:
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A corporate bond is a debt security issued by private corporations to raise money from domestic investors. These bonds are generally brought by investors as these corporations have high credit ratings. These bonds are usually backed by the credit ratings and the repayment ability of the company, which is in the form of the money that is earned by these entities through their investments. Sometimes the physical assets of the entity can be used as collateral for these bonds.
A government bond is a bond issued by the government to raise money from its domestic market. Government bonds mainly issued by the Central Government and are supervised by the Reserve Bank of India. The RBI issues the bonds on the behalf of the government and auctions it to the investors. Bonds are issued by the government to raise money to fund projects related to public welfare and infrastructural development. The government would pay a regular and fixed interest rate to the investors who buy the bonds. The face value of the bonds will be paid to the investors on the maturity date.
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Both corporate bonds and government bonds are financial instruments that allow investors to diversify their portfolios. Investors also consider the risk and the tax implications of these instruments and use it as an opportunity to park their idle funds and benefit from it. Let’s analyse some of the basic differences between the two instruments:
When you buy corporate bonds, the company usually pays interest until you exit the bond or until the bond matures. The interest paid is called the coupon which is a specific percentage of the par value. However, when you buy a government bond, you lend money to the government for a specified period of time. The government will pay you a set level of interest for a regular period. If the interest rate is lower than the bond rate the demand for the bond will rise and it will be considered a better investment opportunity.
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Government bonds are the safest investment options as they contain a sovereign guarantee while corporate bonds are riskier as they contain credit risk, interest rate risk and market risk. However, the government bonds carry a certain percentage of inflation risk and currency risk and there are chances that the investors may receive low returns that are not inflation-beating. Consequently, some corporate bonds are callable, which means they can be demanded for redemption purpose by the issuer. In these cases, the bond is repaid before the specified tenure and the principal is repaid before the maturity date.
This is the rate of returns of all the cash-flows of the bonds, the present bond prices, and the coupon payments until maturity and the principal amount. Since investing in corporate bonds contains higher risk, it yields better returns compared to government bonds. Thus investing in corporate bonds can give a greater profit as it has higher growth potential than government bonds.
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Investors seeking diversification of their portfolios can diversify by combining the government bonds with the corporate bonds. Sometimes you can also combine government bonds with lower quality of corporate bonds to manage and spread the risk equally. You can also include government bonds and corporate bonds as separate investment instruments to diversify your investment portfolio by considering the risks posed by these securities.
Investors investing in bonds must keep their portfolios reasonably diversified. As per the financial planners, the best investment opportunities for Indian retail investors are debt mutual funds. The experts believe that retail investors should avoid direct investment in bonds and should take the mutual funds route to avoid losses. Also, the Indian corporate bond market is not very liquid so the investors must refrain from direct investment in corporate bonds. Retail investors can choose to invest directly in bonds if their investment timeframe aligns with the maturity period of the bonds.
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