What are Bonds?
Bonds are debt instruments issued by corporate bodies, government, or state bodies. These are fixed or floating -income instruments that represents a loan made by an investor to a borrower.
Think of it like this, when a friend asks you for money which you lend him/her with a promise that the friend will return it in say a week’s time. At times the friend may also leave his/her bike or watch with you as ‘Collateral’ for payment. A week passes and the money is returned to you, you return the collateral, if any, and the bond of friendship, which allowed this transaction in the first place is intact.
Similarly, bonds are used by companies, states and even the Central Government to finance projects and operations. Where the issuing party (say the government) promises to return your money after X days (called Maturity Date) and pays you Y (Fixed rate of interest) over and above the money you lend the government.
How are Bonds different from Stocks?
- Bonds are debt instruments. Stock are equity investment as investor becomes part owner
- Stocks are typically issued by companies; Bonds are also issued by Governments
- Bondholders earn interest while stockholders typically receive dividends
- Both may experience capital gains or capital losses if the price at which they sell their holdings is higher or lower than the purchase price
- Bond holders have higher claim on asset than the equity owners
Why Invest in Bonds?
- Bonds provide diversification benefit to investors
- Bonds offer assured returns. They are relatively inelastic to the market fluctuations
- The companies are bound to repay the interest and the principal amount of the Bond
Key Terms to Remember
- Issue Period
Initial Public Offering (IPO) dates indicate the time period within which investor can apply for the bond (acceptance of application form)
A coupon rate is the yield paid by a fixed income security, which is the annual coupon payments divided by the bond’s face or par value.
- Credit Rating
Bonds carry a credit rating assigned by a Credit Rating agency. An example of a rating is CRISIL has rated the bonds ‘CRISIL AAA/Stable’. The higher the rating the safer the bond. AAA Stable is the highest rating possible therefore the bond is the safest.
Bond’s yield is the rate of return it generates to an investor. This can be best understood by the example below:
Assume that a bond with face value of INR 1000 and 6.5% coupon purchased at par has current yield of 6.5%.
- If the price falls to INR 950 the yield would rise to 6.84% (INR 65 interest divided by purchase price of INR 950)
- If the price increases to INR INR 1100, the yield drops to 5.90% (INR 65 divided by purchase price)
- Yield To Maturity
The total returns the customer will receive by holding the bond until maturity
Our Bond Partners
- Golden Pi
- AK Capital Services Ltd
- Bonds India