While most risk-averse investors prefer to invest in bank fixed deposits with low risk and low gain, one must also look at corporate fixed deposits after weighing their merits and limitations
Often, when you begin your investing, the most common advice is to park some amount in fixed deposits. Fixed deposit is an instrument wherein you invest money for a fixed period, with a pre-determined fixed rate of return. Nothing wrong about that as this is the most common investment option with low risk and low gain. A vast majority of the savings are being parked into bank fixed deposits as the investors believe that banks are more trustworthy and reliable. However, one can opt for a corporate fixed deposit also after duly weighing its merits and limitations.
What is corporate fixed deposits?
Companies raise funds for their operations, expansion, etc. from banks and financial institutions. Similarly, with the due approval from the RBI, they can raise funds from the public in the form a fixed deposit and offer a slightly higher interest rate than that of the banks. When the duration of the fixed deposit is longer, they offer a higher rate of interest as the companies can use the funds for long period of time.
Look at the credit rating
Though, corporate fixed deposits offer higher interest rate, it is essential on the investors’ part to do due diligence. One way of checking the financial strength of the company is to look at the credit rating. Always go for companies with AAA rated and again look the rating of multiple agencies. Do not choose the companies based on your familiarity with their products. For instance, company ABC is manufacturing tyres and you use their products for a longer time and found it is good does not mean that the company is good.
Don’t invest in companies in trouble
Before investing, assess the company’s current financial condition and past performance. Ensure that the company have reasonable liquidity comparing to their peers in the industry. Do not get simply attracted because of their offers and higher interest rates. Companies who are not reputed, in trouble either financially or management, stay away from those companies.
It is an unsecured loan
From the companies’ perspective fixed deposits are preferred as their purely ‘unsecured loans’. Unsecured loan is a type of a loan wherein funds are raised based on the borrowers’ credit worthiness only and no collaterals were being offered as a security. As none of the company’s assets are pledged, companies could use the same for future fund-raising purposes. So, as investors you should know that fixed deposits are purely unsecured and there are no specific assets are being backed for the same.
Unattractive for higher tax payers
One of the major reason for investing in corporate fixed deposit is that they offer a higher interest rate than that of the banks. Suppose, if you are in higher tax bracket say 30%, then effective returns i.e. post-tax may not be lucrative since it may not even cover up the current inflation. So, investors in those categories should not prefer to invest in corporate fixed deposits and look for other investment options with similar risk categories such as debt oriented mutual funds or tax-free bonds, etc.
To conclude, corporate fixed deposits are meant for investors who are fixed income oriented and it is essential to do due diligence and consider the above points before investing so that you are out of the vagaries equity market.
The writer is professor of finance & accounting, IIM Tiruchirappalli