Bonds

Bonds are commonly referred to as fixed-income securities and are one of the three main generic asset classes, along with stocks (equities) and cash equivalents. Many corporate and government bonds are publicly traded on exchanges, while others are traded only over-the-counter (OTC).

What is a BOND?

A bond is a debt instrument that is used for raising capital. It is also known as fixed-income security. Bonds are essentially loan agreements between an investor and bond issuer. In this, the bond issuer needs to pay a specific amount at specified pre-decided dates.

Corporations and governments use bonds Investment to borrow money. Governments need money to fund dams, school, roads and other government infrastructure. While corporations need money to buy property or equipment, to hire employees, to undertake projects , for research and development and to grow business in general. However, the problem with most large corporations is that they require more money than a bank can provide. In such cases bond funds are a great solution. Bonds Investment allow several investors to become lenders.

Why should you INVEST in BONDS?

  • Bonds bear fixed rates like FD and average rate of return of a bond is around 10-11% while fixed deposits bear an interest rate of 7-8% on an average.

  • Bonds can be redeeemed before maturity as they are traded in the secondary market.

  • You can do a bond transaction online through your Demat account.

  • No TDS on interest payouts.

  • In cas of long term capital gains, the investor gets the benefit of indexation.

  • A bond transaction is quick. Payment is via RTGS and the bond will be credited into your Demat account by the end of the day.

Types of Bonds in India

There are four major different types of bonds in India. They are:

  • Corporate Bonds: These bonds are offered by private corporations in India. Corporate bonds term can last up to 15 years. Anyone can purchase a corporate bond. However, it has a higher risk of default and it may depend on the corporation, market condition, company’s business and its investment rating.

  • Public Sector Undertaking bonds: Public Sector Undertaking (PSU) bond is a good choice for people looking for medium to long term investment. These bonds are usually backed by the government of India. However, they are sold on a private basis. Here, the government targets investors and offers PSU bonds to them at fixed rates. An investment banker usually acts as a middleman.

  • Emerging Market bonds: These bonds are issued abroad as hard currency to raise capital for the development of third-world countries. Interestingly, these bonds are usually issued in Euros or US dollars to lure investors from those countries. Additionally, Emerging Market bonds offer a high interest rate which is typically paid by the issuer. The success of this bond depends on the country’s economic development.

  • Financial Institutions and Banks: These are vibrant financial instruments that make up most of the bonds in India. The main reason for this is- these bonds are well regulated by banks and financial institutions and have good bond ratings. Usually, large scale investors tend to take up these bonds.

  • Tax saving bonds: These bonds were issued by the Indian government that allowed citizens to either partially or completely be exempted from paying taxes. However, the sale of tax saving bonds ended in early 2018.

 How to invest in bonds in India?

Although the bond market in India is less liquid than the U.S bond market, there are several options available to buy bonds in India.

  • Corporate bonds: Investing in corporate bonds is very simple. When a company issues a bond, you will have to fill out an application form and submit it to any branch of the issuing company along with the required documents and application fee. The documents may include address proof, PAN card, Aadhar card,etc. If you have a demat account, you may fill the details in the form and get the bonds credited to it else you may choose to receive the bonds in a physical format.

  • Government Bonds: Government bonds are sold through official distributors and branches of post offices and banks. You will have to visit any designated branch and submit the application form. You will receive a bond certificate in your name after your request is processed.

Key benefits of investing in Bonds

There are several benefits of bonds. Some of them are:

  • The volatility of short-term and medium-term bonds is lower than equity funds

  • They are liquid

  • In most countries bond holders enjoy a measure of legal protection. In case a company goes bankrupt, bond holders will receive some money back.

  • There are several bonds an investor can choose from depending on his requirements.

What is the difference between Bonds and Stocks?

While Stocks are ownership stakes, bonds are debt securities. They are two ways of an entity to raise fund. When a company issues a stock, it is selling a part of it in exchange of cash. When a company issues a Bond, it is issuing debt with an agreement to pay interest for using the money.

 

In other words, stocks are simply shares of individual companies while bonds are nothing but debt.

FV 10 Lacs

 How to evaluate Bonds?

When evaluating bonds you will have to consider a few aspects such as the price, interest rate, maturity etc. By analyzing these aspects you will be able to determine if these bonds are suitable for investment.

  • Price: This is one of the most important aspects to consider while evaluating the performance of a bond. Bonds are usually traded at a premium, discount or at par in the bond market. 

  • Interest rate and yield: The interest rate is a fixed rate that a bond pays till it matures. The interest rate can be floating, fixed or only payable at maturity. However, fixed rate is the most common interest rate used till maturity. Some issuers however sell floating rate bonds based on a benchmark such as LIBOR or Treasury Bills. Zero-coupon bonds make an interest payment upon maturity and are sold at discounts to their face value. There are two types of yield calculations. The current yield is the annual return on the total amount paid. The yield to maturity is the total amount you will receive on maturity of the bond. Other bonds having redemption provision has yield to call. Yield to call is calculated till the issuer can call the bond.

  • Maturity: Bonds can have maturity between one and 30 years. Maturity is the future date at which the principal will be repaid to you. Bonds can be short-term, medium-term or long-term. Short-term bonds have maturities between one and five years, medium- term bonds have maturity between 5-12 years and long-term bonds have maturity of over 12 years.

  • Redemption: Issuers can redeem a few bonds before their maturity. This enables the issuer to refinance debts in case the interest rates fall. An issuer can call to redeem the bond. A put provision on the other hand allows you to sell back the bonds to the issuer at a specified price before its maturity.

What is the Duration of a Bond?

The bond duration changes with time depending on its price and change in yield. The duration of the bond measures the time it takes to recover half the present value of all future cash flows. The discount rate used to calculate the present value of the cash flows is the bond’s yield.

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