Meaning of Bonds
A bond is a type of investment where investors lend money to the government or a company for some specified period. It is a debt instrument through which the company borrows money from the lender or the bondholder or debt holder and in return, the company pays interest (coupon) to the lender on the principal amount. Bonds are issued for business operations, acquisitions, and business projects.
The issuer and bondholder enter into the contract where the company i.e. the issuer repays the borrowed money with interest on fixed intervals- Monthly, semi-annual, or annual. The bonds have pre-determined interest with a defined period, after which it gets matured.
Important Terms to Understand Bonds
- Face Value or Par Value: it is an amount which tells the worth of the bond. Face value is the basis of calculating the interest rate due to the lenders or bondholders.
- Maturity: The Company that issued the bond has to return the money to the lenders or the bondholders. The bond can have short, medium, or long maturities.
- Coupon: Coupon is the fixed rate of interest paid to the bondholders.
- Price: The bond has two types of prices i.e. Bid Price and Ask Price. The bid price is the highest amount the buyer is ready to pay for the bond on the other hand ask price is the lowest price asked by the seller.
- Duration Risk: Duration risk measures how the bond’s price changes due to the fluctuation in the interest rate in the market.
How Investment in Bonds is Different from Stocks
In India stocks and bonds are the most widely used investment methods.
- The bondholders are lenders while stockholders are the owners in the company/firm/organization.
- There is a defined term of maturity in bonds whereas there is no fixed period for stocks.
How to Invest in Bonds in India
- Government Bonds: The government bonds are issued by both the central government and state government. These bonds are risk-free and are one of the safest ways of investment option to earn interest periodically and principal amount on the maturity of the bond. Interest is paid on a semi-annual basis.
- Capital Gain Bonds: These bonds allow you to transfer the gains from long-term assets like house and land properties into bonds. The investor needs to invest in capital bonds 6 months from the transfer of assets.
The capital bonds issued by RECL (Rural Electrification Corporation Ltd.) and NHAI (National Highways Authority of India) are eligible under section 54EC of the Income Tax Act, 1961
- Sovereign Gold Bond: The sovereign gold bond carries an interest rate that is paid periodically and there is no risk of handling gold physically.
- Corporate Bonds: The companies’ issues bonds for their financial needs and the bondholders earn interest regularly. Corporate bonds pay higher interests than Bank Fixed Deposits and government bonds.
- Convertible Bonds and Inflation-Linked Bonds: Convertible bonds are those bonds that are converted into equity based on pre-specified terms. Inflation bonds are the type of bonds wherein both the principal amount and interest rate are indexed into inflation and these bonds are efficient in surviving inflation risk.
Two Ways of Investment in Bonds in India
- Primary Market: In the primary market companies make initial primary bonds that you can subscribe to through brokers.
- Secondary Market: In the secondary market can be purchased through the retail debt market. You can check trading bonds on NSE. Just like shares each bond has a scrip code so investors can put the scrip code and see the price of the bond.
Some bonds can taxable interest and there are bonds with non- taxable interest so as an investor you should be aware of this. You can explore some specialist debt transaction platforms that are available in India.