How to invest in secondary market bonds
There are many bonds including government and corporate bonds that are available in the secondary market. Here’s how to buy the bonds.
The bond market has witnessed much action in the past year, all thanks to big events such as the coronavirus. While interest rates in the country have fallen, bond prices have gone up and yields of bonds have fallen. Even though yields are lower than before, there are several bonds in the secondary bond market that offer higher yields when compared to conventional investments such as fixed deposits. For instance, Non-Convertible Debentures (NCD) in the secondary market offer yields of over 7.5%. The advantage is that you can use your demat account (the one you use for stock investments) to invest in these securities. Interested in these bonds? Here are the details you need.
What is the secondary bond market
The secondary market is the market where bonds that have been issued come for resale after their initial issue. This is what happens to stocks after their Initial Public Offering (IPO). They get listed on the stock markets. Bonds get listed on the stock markets after they are issued. So, if you were not able to buy a bond when it was issued, you can purchase it from the secondary market.
What to look at before buying bonds in the secondary market
You shouldn’t look at buying bonds that are trading at very low prices. You should look at the yield of the bond rather than the coupon rate offered by the bond.
Yield to Maturity (YTM) is the rate of return you will receive from a bond if you hold it till maturity. Coupon rate will be irrelevant after the bond is listed on the stock markets. YTM of a bond will vary based on the face value of the bond, coupon rate, present market price, and time to maturity of the bond. If a bond’s YTM is more than its coupon rate, the bond will be selling at a discount. If the YTM is less, the bond will be selling at a premium. It is best to buy a bond with a higher YTM. Why? This is because when you buy the bond at a discount, your total return (purchase price + interest received) will be higher.
Duration of the bond is the time taken for a bond to repay its true cost. In simple words, it is the percentage change in the bond to changes in the interest rates. For instance, a bond with a duration of 5 years will fall by 5% if the interest rates rise by 1%. The longer the duration of the bond, the more the risks, because there are greater chances of the bond getting affected by interest rate changes. You need to choose the duration based on your risk profile.
Most of the listed bonds are provided with credit ratings by rating agencies. A credit rating is assigned by the agencies only after the issuing company’s financials and revenue prospects of the company are thoroughly analysed. It is prudent not to invest in bonds that have a rating below AAA. However, if you want to invest in lower rated bonds for higher returns, you need to make sure that the duration of the bond is less. If you are going to hold the bond till maturity, keep yourself updated on the changes in the credit rating.
Note that liquidity in the bond market is not very high. You need to choose securities with meaningful liquidity.
The whole Indian corporate segment is going through a tough phase. Industrial growth is expected to remain weak in the near future. This means that default risks will go up for companies whose financial health isn’t great. Look at the revenue prospects, competitors, promoters and other financials before investing in bonds.
Interest earned on corporate bonds is taxable. However, there is no Tax Deducted at Source (TDS) for Indian citizens.
If you don’t know how to invest in corporate bonds, you can invest in bond funds. These funds invest in bonds or other debt securities. Bond funds usually pay dividends. Fund managers manage all the investments and save individual investors the efforts needed for researching creditworthiness of the company, bond price, coupon rate, yield, and other factors. Since bond funds invest in different kinds of bonds, even a small amount of investment is diversified. The best thing about bond funds is that you can sell the units of a bond fund at any time without worrying about its maturity.
Read this article to know more about which debt funds to choose from now.
Wealthzi.com’s wealth team can help you invest in bonds and bond funds. Start investing now.