Home EssentialsBond Market What is the bond market and how does it work?
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What is the bond market and how does it work?

The bond market is a financial market where debt securities are traded. Consisting of financial instruments like government bonds, corporate bonds, municipal bonds, and many other debt securities, the bond market provides predictable returns compared to the stock market. This market allows individuals and organizations to loan their money to government bodies or corporates as capital for new initiatives and expansions.  Debt security investors earn fixed returns at regular intervals from their investment.

How does the bond market function?

The bond market consists of two parties; the bond investor who lends money, and the bond issuing company who borrows the money and returns it within a fixed period for a predetermined interest rate. There are two ways to transact in bonds; the primary market is where companies issue new debt securities and the secondary market, where existing debt securities are traded.

How does the transaction take place?

Typically, the bond issuing company issues a certain number of bonds for the amount they require as credit. Bond investors can buy as many bonds as per the value they’d like to invest. The principal value of one bond is called the face value of the bond.  And each bond earns an interest rate or coupon on the face value of the bond at regular intervals. For example, if a bond’s face value is Rs 100 and coupon rate is 6%, the bond investor will earn Rs 6 annually.

What affects the return from bonds?

If the bond investor decides to stay invested in the bond till maturity, then there is no change in the coupon rate till maturity. However, if he trades the bond before its maturity date, then the value he gets for the bond is affected by expected inflation rates. The higher the expected inflation, the lower investors will be willing to invest in these bonds, and the lower he pays, the higher yield he’s bound to get from the investment.

For example, if a person buys a bond of Rs 100 at Rs 90 and continues to get a coupon rate of 10%, then the investor who pays Rs 90 is actually getting a higher yield of 11% as compared to the investor who paid Rs.100 and gets 10% yield annually.

What parameters to consider while investing in bonds?

While investing in a bond it is vital to look at parameters like the credit rating of the bond issuing company. Any company with a rating of AAA – A by bond rating agencies are verified to not default. It is best to stick to high rated bonds if you’re a new investor. Also, consider if the bonds are secured or not. Secured bonds will ensure you get back your money in case the company goes bankrupt or has a financial crisis. Take into consideration the tenure and coupon rate as well before making your investment.

How to trade in bonds?

Bonds above Rs 10 lakh are traded in the NSE and BSE, however, bonds of smaller lot sizes are sold through brokers or over-the-counter. The retail bond market in India is still very nascent.

To invest in bonds, you can contact goldenpi.com.

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