How to trade in the secondary bond market

There are many corporate as well as government bonds in the secondary market that have yields of over 8%. Here is how you can trade in them

Kavya Balaji Dec 25, 2019

bond tradingThe bond market has witnessed as much action in the past year as the equity market, all thanks to the NBFC crisis and liquidity squeeze. Take the benchmark 10-year government security. This security’s yield started rising after the RBI announced that it is going to keep the repo rate unchanged. The yield has risen from 6% to over 6.8% per cent in the past year. Currently the benchmark security is trading at 6.84%, which is much higher than the 6.5% offered by most banks on their 10-year fixed deposits.

If you are willing to take a bit of risk, there are corporate bonds that offer yields higher than 8%. For instance, bonds in the secondary market from companies like PFC offer yields of over 8.4%. Read on to know more.

Bonds in the secondary market

You might have heard of government security auctions or seen advertisements for debentures and company bonds. If you missed investing when these were announced, don’t fret as the secondary market is where you could pick these up. Secondary market is where previously issued securities are traded. The biggest advantage is that you can use your demat account (the one used for stocks) to invest in these securities. This is because they are listed on the stock exchanges. But there are several things to look at before you pick any of them.

Which ones to buy?

You could buy either government or corporate bonds in the secondary market. Government securities, or G-Sec as they are called, are dated securities issued by the Government of India and carry a fixed interest rate. Since G-Secs are issued by the government there is nil default risk and therefore G-Secs are considered to be safer than other fixed income instruments. They offer varied tenures ranging from 91 days (short term) up to 30 years (long term). Another advantage is that you could use G-Sec as collateral for taking loans.

Corporate bonds are bonds issued by companies. Since these involve higher risks than G-Sec, the returns on them are also higher. A corporate bond is generally priced on the basis of G-sec prices of comparable tenure. In simple words, price of G-sec is the base on which the spread of a corporate bond gets calculated.

Corporate bonds have become popular over the years. Funds raised through corporate bonds were around Rs 3.7 lakh crore in 2012-13. Now, they are about Rs 6.5 lakh crore. You could choose G-sec based on your investment horizon but you must be mighty careful before buying corporate bonds.

How to choose corporate bonds?

Since one would choose corporate bonds for higher returns, it is prudent to look at the Yield to Maturity (YTM). YTM is the effective return from your bond when you buy it at its Current Market Price (CMP). Bonds are issued at face value but based on demand, supply and the interest rate cycle, prices keep changing. So, you could buy bonds at a premium or discount from the secondary market. When interest rates are moving up, the yields in the secondary market adjust themselves by way of lowering the price. Hence, comparing similar maturing instruments based on YTM is the way to choose a bond. Obviously, you would go for ones which have high YTM. You can ask your broker to help you with YTM calculations or check out websites like IDBI G-sec and Edelweiss for information on them.

But note that corporate bonds are risky, always ensure that you buy ones with high credit ratings. There would be many bonds available in the market which would be giving high yields on account of the low credit ratings. So always choose bonds that have ratings of AA or higher.

Another important criterion would be liquidity. Liquidity in the corporate bond market is pretty dismal. The highest volume would be about 50,000 while the lowest could be even 1 or 2. G-Sec are liquid but a good number of corporate bonds remain illiquid as a result of which one may not get the price that truly reflects the yields. Choose instruments with meaningful liquidity.

The last criterion would be whether you want to sell the bonds or hold on till maturity. This would be crucial as selling the bonds before maturity could result in either a gain or a loss. If you are buying a bond for holding it till maturity then risks are lower – the primary risk in this case is buying it at the right price. If you have intentions of selling, you need to keep track of the prices of the bonds.

How to buy a bond?

You can trade in bonds just like stocks as these too are listed on stock exchanges. You could purchase G-Sec with the help of an online service provider like ICICIDirect or wealth management companies. Even IDBI Bank has a G-Sec portal where you could buy and sell these securities. The same is true for corporate bonds. For a retail investor having a demat account, buying on stock exchanges, through his/her broker would be easier.

What about taxation?

There are no tax benefits for investing in G-Sec and interest is taxable. However, they are exempt from wealth tax and there is no maximum limit to the amount of investment. There is no tax deducted at source (TDS) on the interest earned. No such exemption is applicable for corporate bonds.
Interest earned on corporate bonds and NCDs is taxable and subject to TDS. Both Short Term Capital Gains (STCG) as well as Long Term Capital Gains (LTCG) taxes, are applicable. If you sell listed bonds within 1 year of holding (STCG), it would be taxed according to your tax bracket. If the same is sold after 1 year of holding (LTCG), then you can pay tax on capital gains at 20 per cent with indexation benefit.

Think investing in corporate bonds is too risky? Then, try bond mutual funds. Read this article for more details – What Are The Bond Funds You Should Buy Now?

Kavya Balaji

Kavya Balaji is a senior contributing writer with RupeeIQ. With more than 14 years of experience in the finance space, Kavya loves everything to do with personal finance. She feels financial literacy is important for every household and likes to stick to simple language for explaining personal finance stories. She is a consultant with investment management companies. In spare time, she reads murder mysteries.

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