What is a Bond? What are the Features of a Bond?

A bond is a popular investment option for a person having limited appetite for risk or wanting a steady source of income. If you are looking at investing your funds towards an instrument that can give you a fixed income and lesser volatility, investing in a bond is a good choice for you.

What is a Bond?

A Bond is a loan to the issuer who pledges to return your investment with interest. Mostly companies, state or central governments raise funds through bonds for financing business expenditure and developmental projects. Hence a bond is an investment instrument that can be classified as a fixed income asset. The issuers of the bonds are borrowers and as bondholders, you become the creditors to the issuing authority.

What are the different types of Bonds?

There are various types of bonds which are available. The different types of bonds include:

1. Fixed Rate Bonds:

Fixed-rate bonds are the ones that keep paying interest at a predetermined rate until the bond matures. The interest is calculated at periodic intervals and can be paid monthly, quarterly, semi-annually or annually.

2. Floating Rate Bonds:

The returns on floating-rate bonds are variable. Typically, the issuer of the bond pledges to pay the investor interest that has reference to a benchmark rate like those of RBI and SBI. These are good for hedging against inflation.

3. Zero Coupon Bonds:

As the name suggests, there are no coupon or interest payments made in these bonds from the time they are issued. Investors purchase the bonds at a discounted rate and get repaid a lumpsum par value at maturity. The difference between the discounted purchase price and par value redemption price of the Zero Coupon Bonds is the return on investment.

4. Perpetual Bonds:

Perpetual Bonds do not have a fixed maturity date, so theoretically the issuer does not have to repay the principal ever. In practice however, these perpetual bonds have regular “call dates” – these are predetermined time periods (5years, 10years) after which the issuer has the option but not the obligation, to repay the principal on the bonds. These bonds pay interest payments regularly.

5. Inflation Linked Bonds:

The objective of Inflation Linked Bonds is to stay untouched by inflation.  These are fixed income securities whose principal and coupon are linked to inflation through a price index. They are designed to hedge against long term inflation risk to the bond holders.

6. Convertible Bonds:

Under convertible bonds, you have the option of converting these bonds into shares of the holding company. The conversion option is made available for a particular time period and the number of shares allocated post-conversion is at a predetermined unit. However, if investors do not want the bonds converted into shares, they may hold onto the securities and get benefits of a traditional bond instrument.

7. Callable Bonds:

Callable bonds can be redeemed before maturity and the issuer of the callable bonds may pay the dues to the investor and redeem the bonds at predetermined time. When the issuer calls for the bonds, investors get the face value of the bonds and the interest that has accrued till the date of the call post which, there is no liability on the part of the bond issuer to pay any interest to investors.

8. Puttable Bonds:

In the case of puttable bonds, investors have the right to return the bond to the issuer before the maturity date. The issuer shall make the payment towards the principal at a predetermined rate.

How do Bonds Work?

Bonds are nothing but a way to raise funds for the issuer of the bonds. The funds thus raised get utilized in running a business and carrying out developmental work. A bond investor is typically considered a lender who lends money by means of bonds to the issuer of these bond. The issuer of the bond who is the borrower pledges to repay the principal along with interest.

Bondholders are paid interest – also known as coupon of the bond – at regular intervals like monthly, quarterly, annually etc. Upon maturity of the bond, the principal amount gets repaid into your account along with any pending accrued interest.

Benefits of Investing in Bonds:

With the Bond industry at its nascent stage in India coupled with the limited understanding on the subject, conversations revolving around the Bond markets may not make for an appealing after-dinner dialogue. While many investors tend to underestimate the power of investing in bonds there are some distinct advantages of investing in bonds that make this a great investment option. Some of the advantages include:

Higher Interest:

The returns earned on Bonds are often almost twice of that of Fixed Deposits depending on the tenure. In case of Bond Public Issue, individual investors are often offered higher interest than institutional investors.

Steady Flow of Income:

Bonds are a source of a steady inflow of income for you. Unlike an equity portfolio that is plagued with market volatility, a portfolio with bonds in it can help bring your portfolio stability with a predictable and regular inflow of cash.

Safety and Security:

Investing in Government Bonds come with the highest degree of safety and security and are technically called risk-free investments. While corporate bonds may come with certain degrees of risk, most bonds are backed by collaterals. As a result, in the event of defaults, these collaterals are liquidated to repay your investments.

Portfolio Diversification:

Portfolio diversification is essential to achieve healthy balance between income stability and returns. Bonds lend you that balance in your kitty. When the stock markets fall bonds will help you in preserving the capital.

Enjoy Capital Appreciation:

When the market interest rates fall, investors can see a rise in their portfolio value leading to capital appreciation. This also possible when investing into corporate bonds, and the underlying company improves.

High Liquidity:

Bonds as an investment instrument are considered to be highly liquid since they can be easily traded in the secondary markets through stock exchange. There is no lock in period and in case of emergencies, investors can easily exit their investments.

Advantages during bankruptcy:

In the event of bankruptcy bond holders get priority preference in repayment of their investments as they are considered as lenders.

Low Minimum Investment:

Investments in Primary markets by means of Bond Public Issues start from INR 10,000.

Factors Affecting Bond Prices:

Market Interest Rates:

Interest rates and Prices are inversely related to each other. Which means whenever the market rates fall, bond prices go up. Conversely, if the market rates go up, the bond prices plummet.

Inflation:

Bond prices go down when inflation shows an incremental trend. With the reduction in the rate of inflation, the prices of bonds go up. This is because purchasing power gets eroded at the time of high inflation.

Credit Rating:

A good credit score shows the financial stability of the bond issuer. If the credit ratings go down, the prices of bonds issued by that organization also fall.

Liquidity:

Not all bonds have same secondary liquidity. Bonds issued by governments and large corporates have high liquidity. 

How To Buy Bonds?

Bond Investments are in the process of being simplified – bringing in transparency and accessibility for individual investors. With the introduction of online bond investment platforms like IndiaBonds, investors can now seamlessly invest in a wide variety of bonds online without the need of brokers and middlemen. Invest easily in just 3 simple steps:

1. Sign up on IndiaBonds.com
2. Complete your KYC online in under 3 minutes which requires no paper uploads.
3. Explore bond offers, buy the bond of your choice and make payments online!

Conclusion:

As a parting thought one may conclude by saying bonds make a very prudent investment decision. It lends the necessary stability to your investments and fetches a higher yield than bank instruments like fixed deposits. However, before investing in bonds, you are advised to carry out fundamental research about the company to help you make prudent investment decisions. Like all investment choices, bonds do have their share of risk. But those risk factors are mitigated by its strengths making bonds a very good option for your investment. Therefore one may safely state that bonds are a good investment option and need to be present in your portfolio.

FAQs:

1.    Is a bond a good investment option?

Yes, bonds are a good investment option as they offer a steady flow of income for you.

2.    What is the bond market?

The bond market means the transactional buying and selling of bonds in a marketplace.

3. What is a debt market?

A market, where debt instruments like bonds are sold, is called a debt market.

Disclaimer: Investments in debt securities/ municipal debt securities/ securitised debt instruments are subject to risks including delay and/ or default in payment. Read all the offer related documents carefully.