There are two routes to investing in bonds – primary and secondary markets. When a company comes out with a public issue of bonds, you invest through the primary route. If you purchase a bond from a stock exchange/bond dealing house, it means you are taking the secondary route.
In the current scenario, when quite a few bond public issuances are hitting the market, it is worthwhile analysing the comparative advantages and modalities of investing via the two routes.
The primary advantage
For the retail investor, investing through the primary mode has multiple advantages. For one, the secondary market is not liquid. Also, you may not get the bond with a lot size or maturity that you are looking for. So, even though many bonds are traded on the exchanges, their availability when you want to buy may be limited. In a public issue of bonds, you can apply for a lot size that is in keeping with your affordability.
There are multiple maturity options; you can buy a bond that suits your investment horizon. You have to look at the credit quality of the issuer. As long as the instrument is highly rated by a rating agency and belongs to a reputed business group, you may go ahead. You save on costs as well; there is no brokerage or transaction fee payable in a public issue. Given that so many primary issues are hitting the market, you can diversify as well. That is, you can take exposure to bonds of different issuers and diversify your risk.
However, the secondary route too has an advantage, which stems from the imperfection of the market. The lack of liquidity in the secondary market means that when you want to sell, you may have to settle for a lower price, which results in a higher yield for the buyer. The other side of the coin is that when you contemplate purchasing in a primary issue, there may be a seller offering a higher yield. You may take advantage of this situation and purchase at a relatively higher yield. Extending the logic, there may be sellers in the secondary market at any point of time who require the cash flow, and the yield (annualized return) available may be higher than the correct market level.
Tracking yields
That brings us to the question: how do you track yields available in the secondary market? While data is available in today’s digital era, when you are tracking the website of the exchange, i.e., NSE/BSE for historical traded prices or ask price to sell, it is in terms of price. Sounds logical, but there is one difference between trading equities and bonds. In bonds, deals are done on the basis of yields; i.e., the annualized return you would get if you hold the bond till maturity.
The price corresponding to the yield is derived by using the XIRR function in an excel spreadsheet. XIRR stands for extended internal rate of return. If you are savvy in excel-based calculations, you can calculate yields by plotting the cash flows, i.e., coupons and principal and calculate the traded price as the balancing figure for the agreed XIRR. The other method in excel is the XNPV formula, which calculates the net present value. Conversely, for a given price at the exchange, you can calculate the XIRR by plotting the price and cash flows, i.e., coupon and principal. If the resultant yield, i.e., XIRR is higher than similar quality bonds, you know you are getting a good deal.
The issue is, not everybody is savvy in such calculations. While starting out, you may take help from a professional and thereafter follow the logic for future calculations. The other way of doing it is taking quotes from a bond dealing house, where the quotes are available in terms of yields, as per market convention.
To conclude, the primary route is easy and simple—all that you require is a demat account. You can apply through the merchant banker or a sub-broker. The issuances, being at par, i.e., not at a premium or discount, your yield is the same as the interest rate of the bond. In the secondary route, you may get good bargains from time to time. To take advantage of these opportunities, you may go with a bond dealing house that can guide you on the effective returns. Of course, you must buy a bond from the secondary market only if it suites your investment horizon and investment quantum. Alternatively, you may pick up excel calculation skills and track the price quotes at the exchanges.