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Bonds are considered among the safest investment tools in the Indian investment market and have earned massive popularity for the same. The basic definition of bonds is the same, but multiple features enable distinct categorisation. Flexibility and diversity make bond investments more interesting and lucrative for different types of investors.
Defining Bonds
Bonds are fixed-income investment options. Government, governmental bodies, and corporations may often require capital for the development of operational projects. Instead of going to the bank, they issue bonds for the investors to collect the funds. While bonds are investment tools, they are also similar to a loan agreement between the bond issuers and the bondholders.
How Are Bonds Issued?
RBI issues the bonds through auctions on behalf of the government. Government bonds are issued as and when needed, based on the financial requirement and gap in the collected revenue. The retail direct portal of RBI holds the auctions for different securities on specific dates. Notices, press releases, and advertisements are published prior to the issuance to inform the investors.
Similarly, corporate entities issue bonds based on their necessity.
How Do Bonds Work?
Bonds are issued with pre-set maturity periods, interest rates, and other terms. Once the payment is made and the bond is issued, the investors receive periodic interest payments or coupons at regular intervals (semi-annually, annually, etc.). The principal amount is returned as the bond matures.
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Types of Bonds
As per the issuing entity, bonds can be categorised into:
- Government Bonds: Issued by the Central Government of India
- Corporate Bonds: Issued by companies of different shapes and sizes
- Municipal Bonds: Issued by local municipalities
Bonds are categorised into the following types based on the interest rates:
- Fixed Rate Bonds: The rate of interest remains the same throughout the maturity period.
- Floating Rate Bonds: The interest rate is reset at regular intervals
- Zero-Coupon Bonds: No coupon (interest) is paid; rather, the bond is issued at a discounted price.
- Inflation-Linked Bonds: The principal and coupon are adjusted as per the inflation rate to create a hedge against inflation.
You will find many other bond names, credit to some unique features, like:
- Callable Bonds: The bond issuer can call the bonds, i.e., buy the bond back from the investors before the maturity period ends.
- Convertible Bonds: These hybrid bonds can be converted into company stocks.
- Perpetual Bonds: These bonds have no maturity period. There is no date for returning the principal. The bond issuer keeps generating interest in the investors’ account for perpetuity.
Key Features & Benefits of Bonds
The array of bonds brings numerous features to benefit investors. Some of these are:
- Flexible Maturity Period: There are short-term, mid-term, and long-term bonds available to serve different investment goals.
- Stable Income: The periodic coupon payments form a regular income source.
- Liquidity: Many bonds can be sold in the secondary market. The liquid nature can be helpful during a financial crisis or sudden capital requirement.
- Safety of Investment: Government bonds have almost no default risk. Corporate bonds can carry a low risk, but bonds with high credit ratings can reduce that risk to a great extent.
Wrapping Up!
Bonds are suitable for investors with low-risk appetites. These investment tools can easily balance the risk factor of a high-risk portfolio, as well. Remember that although default risk is low, risks like interest rate risk and prepayment (called before maturity) risk remain.
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FAQs About What are Bonds?
1. What is a bond in simple terms?
In simple terms, the bond is the issuer taking a loan from the investors at a particular interest rate for a specified period.
2. Are bonds a good investment?
Bonds can be good investment options for those looking for comparatively safer investment options and those searching for a regular source of income.
3. What is the face value of a bond?
Face value refers to the price the bond has been issued.
