What is a Bond?, Types of Bonds, Why Should One Invest in it?

Bond Definition, Types and Features: Many companies and state or central governments raise funds through bonds to provide money for business expenses and development projects.

Bonds are a popular investment option for people who can afford limited risk or want a consistent source of income. If you are considering investing your funds in an instrument that gives you a fixed income and has low volatility, then investing in bonds is a good option for you.

What is a bond?

A bond is essentially a loan to the issuer, who promises to return your investment with interest. Most companies and state or central governments raise funds through bonds to finance business expenditure and development projects. Therefore, bonds are investment instruments that can be classified as fixed income assets. The issuer of the bond is the borrower and as a bond holder you become the lender to the issuer.

What are the different types of bonds?

There are many types of bonds available now. Different types of bonds include:

1. Fixed Rate Bond:

Fixed-rate bonds are those that pay interest at a predetermined rate until the bond matures. Interest is calculated at fixed intervals and can be paid on monthly, quarterly, half-yearly or yearly basis.

2. Floating Rate Bond:

Returns on floating-rate bonds vary. Generally, the issuer of the bond promises to pay interest to the investor at a rate which is decided by the benchmark rate of RBI and SBI. These are considered good for protection from inflation.

3. Zero Coupon Bond:

As the name suggests, these bonds do not have any coupons or interest payments from the time of issue. Investors buy the bond at a discounted rate and receive a lump sum payment based on the value upon maturity. The difference between the discounted purchase price and the value received at the time of redemption after maturity is the return of a zero coupon bond.

4. Perpetual Bond:

With perpetual bonds there is no set maturity date, so in theory the issuer never has to repay the principal. However, such bonds have regular “call dates” – these are predetermined time periods (5 years, 10 years) after which the issuer has the option, but not the obligation, to repay the principal on the bond. it occurs. These bonds make regular interest payments.

5. Inflation Linked Bonds:

The purpose of inflation linked bonds is to protect against inflation. These are fixed income securities, whose principal and coupon prices are linked to inflation through indexing. These are designed to protect bond holders from the risk of inflation over the long term.

6. Convertible Bond:

In convertible bonds, you have the option to convert these bonds into shares of the holding company. This option is made available for a specific time period and the number of shares allotted after conversion is based on a pre-decided unit. However, if investors do not want to convert their bonds into shares, they can still hold the securities and enjoy the benefits of traditional bond instruments.

7. Callable Bond:

Callable bonds can be redeemed before maturity and the issuer can pay the outstanding amount to the investor or can redeem the bond at a pre-determined time. When the issuer calls a bond, investors receive the face value of the bond plus interest until the call posting date. In this, the issuer does not have the responsibility to pay any kind of interest to the investors.

8. Putable Bond:

In case of putable bonds, investors can return the bond to the issuer even before maturity. In this, the bond issuer will pay the principal amount based on the pre-decided rate.

How do bonds work?

Bonds are nothing but a way for the issuer to raise money. The money raised in this way is used to run the business and do development work. A bond investor is generally considered a lender, who lends money through bonds to the issuer of these bonds. The issuer of the bond, i.e. the one who is borrowing, promises to repay the principal amount along with interest.

Interest is paid to bond holders at regular intervals such as monthly, quarterly, annually, etc., which is also known as the coupon of the bond. On maturity of the bond, the principal amount along with the remaining interest is returned.

Advantages of investing in bonds:

The bond industry in India is in its nascent stage and due to limited understanding of the subject, bonds do not prove to be an attractive topic for general conversation about markets. While many investors underestimate the benefits of investing in bonds, there are some special advantages to investing in bonds, which make them an excellent investment option. Some of those benefits include:

High Interest:

The returns from bonds are often almost double that of fixed deposits and depend on the tenure. In case of bond public issues, individual investors are often offered higher interest than institutional investors.

Regular Earning:

Bonds are a source of continuous earning for you. Unlike an equity portfolio that is prone to market volatility, a bond portfolio can help you ensure predictable and regular earnings.

Safety and Security:

Investing in government bonds comes with a lot of protection and security and it is technically called a risk-free investment. While corporate bonds carry some degree of risk, most bonds are secured by collateral. This results in the collateral being sold to return your investment in case of default.

Portfolio Diversification:

To achieve a better balance between stability of earnings and returns, it is important to have a diversified portfolio. Bonds bring that balance to your portfolio. When the stock market falls, bonds will help you protect your capital.

Enjoy Capital Appreciation:

When market interest rates fall, investors may see the value of their portfolio increase, leading to capital appreciation. This is also possible when investing in corporate bonds and the underlying company is improving.

High Liquidity:

As an investment instrument, bonds are considered highly liquid as they can be easily traded in secondary markets through stock exchanges. There is no lock-in period and investors can easily withdraw their investments in case of emergency.

Priority during bankruptcy:

In case of bankruptcy, bondholders get priority in repayment of their investments because they are considered creditors.

Low Minimum Investment:

Investing in primary markets through bond public issues starts from Rs 10,000.

Factors affecting bond prices:

Market Interest Rates:

Interest rates and prices are inversely proportional to each other. This means that whenever market rates fall, bond prices rise. Whereas if market rates increase, bond prices decrease.

Dearness:

When inflation increases, bond prices decrease. Bond prices increase as the inflation rate decreases. This is because in times of high inflation the purchasing power of people reduces.

credit rating:

A good credit score indicates the financial stability of the bond issuer. If the credit rating goes down, the prices of bonds issued by that organization also fall.

Liquidity:

Not all bonds have the same secondary liquidity. Bonds issued by governments and big corporates have more liquidity.

Conclusion:

In passing, we can conclude by saying that bond investments are very prudent decisions. It provides the required stability to your investments and offers higher yields than bank instruments like fixed deposits. However, before investing in bonds, you are advised to do fundamental research about the company, so that you can take an informed decision. Like all investment options, bonds also have risks, but those risks are mitigated by its strength, making bonds a very good investment option for you. Therefore, one can safely say that bonds are a good investment option and should be a part of your portfolio.