Multiple versions of information about bonds may leave a potential investor confused. Bonds in reality are simple debt instruments issued by an entity with the promise of repaying the principal and interest at defined intervals of time. Since the interest and principal are paid at the agreed periods, bonds fall under the category of fixed-income investments.
This article is a simplified guide to understanding what are bonds and the practical steps that can be taken to get started with bond investments. Some of the topics we cover include:
Let’s get started and understand the several reasons why bonds are a good investment option.
What is a Bond?
A bond is a contract between the borrower and the lender (investor), whereby the borrower agrees to issue a debt instrument to the lender and repay the principal, while also making timely payments of interest at a pre-determined rate. In simple words, a bond is a loan made by a lender to the borrower (issuer of the bond).
Bonds are usually issued by PSUs, government organizations, corporates, and other entities as a way of financing large projects like infrastructure, business expansions, or in some cases for funding working capital requirements.
Types of Bonds
Bonds can be broadly categorized as listed and unlisted bonds and are regulated by SEBI. The ones traded actively on BSE and NSE are listed bonds and typically include bonds from listed companies and government entities. Unlisted bonds are typically issued by private organizations and are not actively traded.
Bonds can further be differentiated based on various other parameters including:
- Interest rates – Fixed/floating or zero-coupon rate bonds
- Purpose – War bonds, Climate bonds
- Priority of repayment – subordinate bonds, senior bonds.
- Issuer – Corporate bond, Government bond, Municipal bond, RBI Bond
- Rating – AAA, AA, BBB, BB, C, D (By agencies like CRISIL, ICRA, CARE based on financial strength of the issuer)
- Others – Perpetual bonds, Inflation-indexed bonds, bearer bonds, convertible bonds, and sovereign-gold bonds.
Government Bonds:
These are debt securities issued by a government to fund its spending. In India, these are often called “G-secs” (Government Securities). They are considered low-risk, as they are backed by the government.
Corporate Bonds:
Issued by companies to raise capital for operations or expansion. They typically offer higher interest rates than government bonds but come with a higher risk, depending on the company’s financial health.
Municipal Bonds:
These are bonds issued by state or local governments to fund public projects like infrastructure. In some countries, the interest earned on municipal bonds may be tax-exempt.
High-Yield Bonds:
Also known as “junk bonds,” these are corporate bonds with lower credit ratings, meaning higher risk but higher potential returns. Investors demand higher interest rates due to the greater risk of default.
Investment- Grade Bonds:
These are bonds issued by entities with strong credit ratings (BBB or higher). They are considered safer and offer lower yields compared to high-yield bonds but are more reliable for steady returns.
How Do Bonds Work?
Bonds are loans made by investors to the issuer (government, company, etc.). In return, the issuer pays regular interest (coupon payments) and returns the principal (face value) at maturity. Bonds have a fixed term and pay a set interest rate.
Features of Bonds
Bonds are a versatile investment vehicle that can serve different financial goals, from steady income to capital preservation, making them a key component in diversified portfolios.
Key Features of Bonds:
- Face Value (Par Value): The face value is the amount the bondholder will receive when the bond matures, which is also used to calculate interest payments.
- Coupon Rate (Interest Rate): The coupon rate refers to the interest that the bond issuer pays to the bondholder, usually expressed as a percentage of the face value. Payments are typically semi-annual but can be annual or quarterly.
- Maturity Date: The maturity date specifies when the bondholder will be repaid the face value. Bonds can be short-term (less than 1 year), medium-term (1-10 years), or long-term (over 10 years).
- Issuer: Bonds are issued by entities such as governments, corporations, or municipalities. The issuer’s creditworthiness affects the bond’s risk level.
- Yield: Yield is the return earned on a bond, considering the bond’s current market price, coupon rate, and maturity. Yields can fluctuate based on market conditions.
- Credit Rating: Rating agencies (e.g., CRISIL, CARE, ICRA) assign ratings based on the issuer’s creditworthiness. Higher-rated bonds (e.g., AAA, AA) are safer but offer lower yields.
- Market Price: Bonds can be traded in the secondary market, and their prices fluctuate depending on interest rates and issuer credit quality. When interest rates rise, bond prices typically decrease.
- Callability: Some bonds are callable, meaning the issuer can repay them before maturity. Callable bonds usually offer higher interest rates to compensate for the risk of early repayment.
Advantages of Investing in Bonds
- Diversification – Bonds are a good way of diversifying the portfolio and protecting capital for those with low-risk appetites.
- Low risk – The risk associated with bonds in comparison to equities is lower. Most of the bonds are secured in nature and are backed by some form of collateral.
- Regular receipts – Bonds provide a fixed stream of income with regular interest payments.
- Low default – Bonds issued by the government have a low chance of default and are generally secured by collateral.
- Stability Compared to Stocks – Bonds are generally more stable than stocks because they provide fixed interest payments and return the principal at maturity. Unlike stocks, whose prices fluctuate based on market performance and company profitability, bonds are less volatile and offer a steady income stream, making them a safer investment in times of market uncertainty.
- Predictable Returns – Bonds offer predictable returns in the form of regular interest payments (coupons). These payments are set at the time of purchase and continue until maturity. This predictability helps investors plan their income and gives them confidence about how much they will earn, unlike stocks, where dividends may vary or be absent.
- Portfolio Diversification – Including bonds in an investment portfolio can help balance risk. Stocks and bonds often move in opposite directions – when stock markets fall, bonds tend to perform better. This diversification reduces overall portfolio risk, as the steady performance of bonds can offset stock market volatility.
- Lower Risk Options for Conservative Investors – Bonds, especially government and investment-grade corporate bonds, are considered low-risk investments compared to stocks. Conservative investors, who prioritize preserving their capital over high returns, often choose bonds because they provide reliable income and have lower chances of losing principal, especially if held to maturity.
The primary and secondary bond markets of India are massive and as of January 2023 aggregate to about $1.8 trillion.
How to Invest in Bonds?
Multiple questions about investing in bonds in India have either been left unanswered or are plagued by unambiguity. Here is a clear guide to buying bonds online.
Listed Bonds are issued in the primary market when an entity looks to raise funds for the first time. But to buy/trade already issued bonds, individual investors should do so in the secondary market.
Investors with the clarity of holding a bond until maturity can buy a bond from the primary market itself.
Various ways through which bonds can be bought are:
NSE goBID
An investor interested in buying government bonds, treasury bills, and G-Secs can visit NSE goBID, complete KYC, and submit necessary documents like PAN, Aadhaar, demat, and bank details. The G-Sec units will be credited directly to the demat account of the investor upon completion of payment. The NSE goBID is managed by the Government of India and ensures secure transfer of data and funds.
Brokerage Houses
The best way to easily access listed bonds in India is to contact your broker and enquire about active and upcoming bond issues. Brokerage houses like Zerodha, Upstox, AngelBroking, and Groww provide highly rated PSU and corporate bonds.
Online Platforms
Multiple online platforms provide retail investors an option to open a trading account for free with minimum investment as low as Rs 1000 and participate in listed bond market. These platforms offer MLDs, government securities, and corporate bonds with offer documents specifying details of the bond and the ratings. Examples of such platforms include indiabonds.com, goldenpi, and more.
RBI Direct
RBI Retail Direct scheme is another avenue for individual investors to buy government securities by opening a ‘Retail Direct Gilt (RDG) account with RBI. The investor can place orders to buy T-Bills, Sovereign Gold Bonds, and bid for first-time issues from the primary market. On due dates, the bank account of the investor is credited with interest and maturity proceeds.
Jiraaf
Jiraaf is an online platform to invest in fixed income investments. One can easily buy curated unlisted corporate bonds of great private organizations on the platform. Opportunities that go live on Jiraaf undergo a rigorous due diligence process before being made available to investors. All information is transparently made available to investors to evaluate risk and return before undertaking an investment.
Who Should Invest in Bonds?
Bonds are suitable for:
- Conservative Investors: Those prioritizing safety over high returns, as bonds offer lower risk.
- Income Seekers: Investors wanting regular, stable income through interest payments.
- Risk-Averse Investors: People who prefer less volatile options compared to stocks.
- Retirees or Near-Retirees: Those seeking capital preservation and steady income in retirement.
- Diversifiers: Investors looking to balance risk by adding stability to a stock-heavy portfolio.
- Long-Term Investors: Individuals focused on preserving capital with steady returns over time.
Closing Thoughts: What is a Bond
Diversify your portfolio by investing in different investment avenues including bonds. Bonds are considered a safe haven for investors due to their low-risk nature compared to equity products, and their ability to preserve capital and generate regular income. In the event of a bond default due to the borrower’s inability to pay back the investors, bondholders, who are creditors of the company, have a higher priority compared to equity shareholders. For all the right reasons, buy bonds!
Discover fixed income investments with Jiraaf, a SEBI registered online bonds platform that educates and brings access to a wide array of bonds. Sign up today to explore diversified fixed income investment opportunities to support your goal based wealth creation journey. Start investing!
