Easy Guide To Corporate Deposit Returns And Associated Risks
Key Takeaways:
Corporate deposits in India, also known as company fixed deposits, are term deposits offered by non-banking financial companies (NBFCs) and other corporate entities. These deposits are similar to traditional fixed deposits offered by banks but typically offer higher interest rates.
Explore the risk-return profile of corporate deposits, factors affecting interest rates, and the creditworthiness of corporate entities to invest smartly.
Understanding Corporate Deposits
Corporate deposits are a form of investment where you deposit money with corporate entities for a fixed tenure at a predetermined interest rate.
Unlike traditional fixed deposits, these deposits are not insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC), which means they carry a higher risk. However, they offer higher returns, making them an attractive option if you are seeking better yields.
Risk-Return Profile of Corporate Deposits
Several factors, including the creditworthiness of the issuing entity, market conditions, and the overall economic environment, influence the risk vs return of corporate deposits. Here are the key components of their risk-return profile.
Expected Return: Corporate FD rates are higher compared to traditional fixed deposits offered by banks. This higher return is compensation for the increased risk associated with these investments. Compared to traditional FDs, you can usually enjoy 1-2% higher interest rates on corporate deposits.
Risk Measures: The primary risks associated with corporate deposits include credit risk, liquidity risk, and interest rate risk.
Credit risk refers to the possibility that the issuing entity may default on its obligations. Liquidity risk is the risk that the investor may not be able to withdraw their funds easily. Interest rate risk is the risk that changes in market interest rates may affect the value of the investment.
Volatility: Corporate deposits are generally less volatile than equity investments but more volatile than traditional bank fixed deposits. The financial health of the issuing entity and market conditions influence their volatility.
Beta: Beta measures the sensitivity of an investment's returns to market movements. Corporate deposits typically have a lower beta compared to equities, indicating that they are less sensitive to market fluctuations.
Value at Risk (VaR): VaR measures the maximum potential loss an investment could experience within a given time frame at a specific level of confidence. Corporate deposits with higher interest rates may have a higher VaR, reflecting the increased risk.
Balancing Higher Returns and Risk of Corporate FDs
Investing in corporate deposits in India requires careful consideration of your risk tolerance and investment objectives. Here are some steps to help you assess whether corporate deposits are suitable for you.
Evaluate Your Risk Tolerance: Determine your risk tolerance by considering factors such as your investment horizon, financial goals, and ability to withstand potential losses. If you have a high-risk tolerance and seek higher returns, corporate deposits may be suitable for you.
Analyse the Issuing Entity's Creditworthiness: Check the credit ratings of the corporate entities offering deposits. Choose entities with high credit ratings to minimise credit risk.
Compare Interest Rates: Compare the interest rates offered by corporate deposits and traditional fixed deposits. Consider the trade-off between higher returns and increased risk.
Diversify Your Investments: Diversify your investment portfolio to spread risk. Consider allocating a portion of your investments to corporate deposits while maintaining a balanced portfolio with other asset classes.
Monitor Economic Conditions: Stay informed about economic conditions and market trends that may impact interest rates and credit risk. Adjust your investment strategy accordingly.
Corporate deposits in India offer an attractive investment option if you are seeking higher returns compared to traditional fixed deposits. However, they come with increased risks, including credit risk, liquidity risk, and interest rate risk. By understanding the risk-return profile, you can make smarter decisions to build your wealth.
Frequently Asked Questions
1. Are corporate deposits safe for conservative investors?
Corporate deposits are generally riskier than traditional fixed deposits offered by banks because they are not insured by the Deposit Insurance and Credit Guarantee Corporation (DICGC). Conservative investors who prioritise capital preservation may find them less suitable due to the higher credit risk associated with corporate entities.
2. How do I check a company’s credit rating?
You can check a company's credit rating through credit rating agencies like CRISIL, CARE, ICRA and Brickwork Ratings. These agencies provide detailed reports on the financial health and creditworthiness of companies.
3. Can corporate deposits offer better rates than bank FDs?
Yes, corporate deposits typically offer higher interest rates compared to fixed deposits offered by banks. While regular FDs may offer rates between 5% and 7%, corporate FDs may offer rates ranging from 7% to 9% or even higher, depending on the creditworthiness of the issuing entity.
4. What happens if the company defaults?
If a company defaults on its corporate deposits, investors may face significant financial losses. The company may enter bankruptcy proceedings, where secured creditors are paid first, followed by unsecured creditors. The recovery of funds can be uncertain and may take a long time.
5. Are corporate deposits suitable for short-term goals?
Corporate deposits can be suitable for short-term goals if the tenure aligns with your financial objectives. They often offer flexible investment periods ranging from a few months to several years.