1.Discuss about the different kinds of risks involved while investing in bonds and debentures?
Bonds are subject to various risk types, including credit, market, interest rate, and inflation risks.
- Credit risk is that the bond issuer may default before the bond matures.
- Market risk is if bond values continue to fluctuate in response to market conditions.
- Interest rate risk is that bond prices will fall as interest rates rise.
- Inflation risk is that the total return on a bond will not outpace inflation.
2. What happens when company defaults their bonds and doesn’t pay their interest? What option do investors have?
There are two circumstances in which a company can issue bonds.
a) The bonds are being issued by a company which is registered under RBI or SEBI
b) The bonds are being issued on a personal note.
Bonds being issued by a company which is registered under RBI, SEBI & NCLT.
If the company fails to pay interest, the investors can seek redressal through the NCLT (National Company Law Tribunal). They will assess the company’s position using specific criteria (financial, is the bond secured? Issuances of secured tranche bonds). Following the evaluation, the investor would receive the funds in some form or may not, depending on the prevalent scenarios.
The bonds are being issued on a personal note.
If the bonds are issued on a personal note (among friends, acquaintances, and references) and the company fails to pay. The investor will receive nothing in return, and no government agency will intervene in such matters.
3. What are covered bonds and is it relatively safer than NCDS?
Covered bonds are debt securities issued by a bank or Non-Banking Financial Company (NBFC) that are secured by a pool of assets. If the issuer fails to make a payment, the amount can be recovered from the pool of assets.
And, yes, it is relatively safer than NCDs because Covered bonds are divided into tranches. It could be both a secured or unsecured instrument. Why is it a secured instrument? Because you receive the entire principal amount back whenever you require. You have a legal right to demand payment from the NBFC, which is also covered by the pool of secured assets.
Second, if any NBFC fails to make a payment, you can recover the amount from the cover pool, which is the asset portfolio comprised of collateralized assets that have been used to back up this covered bond.
The third factor is the additional layer of protection that has been added to it. That is what the collateral is. It could be in the form of property, gold, business, or anything else. It is higher in terms of the loan value. For example, if the loan is worth 20 crores, the collateral will typically be worth more than 20 crores.
It could be 1.2 or 1.3 times, or it could mean extra coverage.
4.How many companies have defaulted and bonds have been returned by the RBI in last five years?
In India’s history, six companies have declared bankruptcy. There has only been one bond written off. It was a YES bank amounting to approximately 8415 crores
Recent Defaulted NBFCS
- Infrastructure leasing & Financial services Limited (il&fs) – INR. 94,000cr
- YES, bank – INR. 52,611.7cr
- Altico capital India ltd.
- Laxmi vilas bank – INR. 330 cr
- Srei infra/ equipment shri radha krishna export industries ltd –INR. 36,000cr
- Dhfl dewan housing finance corporation ltd –INR. 90,000cr
5.What are senior bonds and subordinated bonds?
Senior Bonds are the bonds that are considered before other junior bonds in the hierarchy of payment during liquidation. Senior Bonds come with lower risk. Subordinate bonds come with higher returns and relatively higher risk. In the extreme case of liquidation of the Bond Issuing company, “senior bonds” are paid off before “subordinate bonds.
6. Why there are TIER-1 & TIER-2 bonds. Can you explain in detail?
Tier I
Bonds are also called Perpetual Bonds. As per BASEL III norms, theoretically, these bonds can be carried on till infinity. In reality, they come with a call option after 5 years or 10 years from the date of issuance. It is a popular option among Banks to raise capital to meet their core capital (Tier I capital) needs, as instructed by RBI.
They carry considerable risk and hence pay high-interest rates to investors. The issuer can skip interest payments if the current year’s business is in a loss. In dire conditions, it can get converted to equity (with approval from RBI). Hence they are also called “quasi-equity”. If RBI approves, then it can be written off up to the full value as well
Note: In case of winding up of the issuer, if any payment is to be made to Tier I capital holders, ATI bondholders are paid before equity holders. However, in case the Bank is getting merged with another Bank due to its non-viable business state, then AT1 Bonds can be written off fully while keeping the equity capital unaffected.
Tier II
As per BASEL III norms, Banks raise money via Tier II bonds to meet regulatory norms around capital adequacy. Tier II bonds are subordinated debt and hence not the first to be paid during liquidation process. Tier II bonds are senior to Tier I Bonds.
Note: When a bank has to write off losses, it will first write off Tier I bonds and then, if required, move on to Tier II bonds. It can also be written off if PONV (point of non-viability) is triggered.
7.Do unlisted bonds issue also under SEBI governance? What is the seniority of the proceedings on bankruptcy?
If a company is a financial service provider or a bank and wants to issue bonds, it must register with SEBI, the RBI, and the NCLT. Companies must be licenced by these government bodies in order to issue public bonds. It is not required for personal issuances, and those government bodies will not intervene during defaults.
If the bond is unsecured and the issuer is registered with the RBI or SEBI, either of them will intervene and protect the investors in the event of bankruptcy.
It will find a way to get the investors’ money back, and the percentages will vary depending on the parameters, but some money will be returned to the investors.
8.What is the difference between YTM and coupon rate?
The primary distinction is that the coupon rate is fixed on the bond tenure throughout the year. In contrast, yield to maturity changes with the number of years until maturity and the current price at which the bond is traded.
9.Global Interest rates are at all-time low, is it OK to invest in bonds?
If an investor intends to invest in bonds, they should hold them until maturity. Because the launch is safe and secured, and the returns are commensurate with required payments, it is better to go ahead and invest in bonds.
We need to look at two scenarios;
- If the investor intends to trade, for example, buying the bond at a lower price and selling it at a higher price, the risk is that the interest rate will fall, and it is impossible to predict how the market will fluctuate. It is entirely dependent on the intention and risk of the investors.
- If the investor is excepting a good yield through bond as an alternative fixed regular return, then it is a good time to invest.
10. Would it make sense to exit current positions in equity, very low profits and invest lump sum in bonds?
If the equity market provides consistent returns on investment, it is best to stay in it. In case the equity market stumbles frequently and you are losing money on your investment and do not want to carry the loss forward, you can diversify your portfolio to align with your financial expectations. Before investing in bonds, you must determine whether the bond investment return is greater than the loss in the equity market.
11. Why bond investment during volatile times?
Bonds are one of the great assets to use for fixed income investments and portfolio diversification. And it is a fact that because of the turbulent market, many investors have seen significant losses in their equity at present. They can protect themselves by shifting their assets to fixed income. Bonds can help them succeed in fixed income. Therefore, there are now even more opportunities. The only justification is that you can invest in fixed income, particularly bonds, at any time to stabilise your portfolio.
12. How to save capital gain
REC issued two kinds of bonds.
The first is taxable bonds, and the second is tax-free bonds. The interest earned on Rec taxable bonds is unquestionably taxable in accordance with the customer’s tax liability. The interest on tax-free bonds is completely exempt from taxation.
However, if I sell the bond at a higher price, there will be capital gains. These capital gains will be subject to capital gains taxation, which I will obtain if it is ten months. If it is more than twelve months, it will be 10%.
13. How the RBI rate hike will impact the bond and government security funds? Expecting more rate hike in the coming months.
The yields of the current bonds will increase as a result of the RBI rate hike. Now that yield and bond price are inversely correlated, consequently, the bond price will decrease, hence bonds will cost less. The government intends to raise INR 3.3 billion through the sale of government securities. Because the RBI is raising the rate, the government securities will effectively be issued at a higher interest level, at a higher cooper(interest) level. The government will have to pay the bondholders a higher amount in interest, increasing the government’s expense.
Note: The yield will increase if the RBI raises the REPO rate and it will decrease if the repo rate is lowered.
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4 comments
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