In the stock market, bonds are a type of debt investment. When you purchase a bond, you are essentially lending money to an entity (such as a corporation, government, or municipality) in exchange for regular interest payments over a fixed period of time. At the end of the bond’s term (maturity date), the principal amount of the bond is repaid to the investor.
- Issuer: The entity that issues the bond, such as a government, company, or organization, needs money and borrows it from investors.
- Face Value: The amount the bond is worth at maturity, typically $1,000 for corporate bonds.
- Coupon Rate: The interest rate paid to the bondholder, usually on an annual or semiannual basis. This rate is fixed when the bond is issued.
- Maturity Date: The date when the bond’s principal (face value) is due to be repaid.
- Yield: The return on investment (ROI) for the bondholder, based on the price paid for the bond and the interest payments.
- Fixed Coupon Rate Bonds
- Description: These bonds have a predetermined and fixed interest rate (coupon) that is paid to bondholders periodically, typically semi-annually or annually.
- Example: A bond with a face value of ₹1,000 and a fixed coupon rate of 8% will pay ₹80 annually, regardless of market interest rate changes.
- Advantage: Predictable returns.
- Disadvantage: Bondholders face interest rate risk; if market rates rise, the bond becomes less attractive.
- Floating Coupon Rate Bonds
- Description: These bonds have an interest rate that is not fixed but fluctuates based on a benchmark, such as the repo rate or LIBOR.
- Example: A bond tied to the repo rate + 2% will adjust its coupon payment if the repo rate changes.
- Advantage: Protection against rising interest rates.
- Disadvantage: Uncertainty in interest income.
- Zero Coupon Bonds
- Description: These bonds do not pay periodic interest. Instead, they are issued at a discount to their face value and redeemed at par.
- Example: A zero-coupon bond with a face value of ₹1,000 might be sold for ₹800 and redeemed at ₹1,000 after maturity.
- Advantage: Suitable for investors seeking a lump sum at maturity.
- Disadvantage: No regular income; higher interest rate risk.
- Callable and Puttable Bonds
- Callable Bonds:
- Description: Issuer has the right to redeem the bond before maturity at a predetermined price.
- Advantage: Beneficial to issuers when interest rates fall, as they can refinance at lower rates.
- Disadvantage: Risk of reinvestment for bondholders.
- Puttable Bonds:
- Description: Investors have the right to sell the bond back to the issuer before maturity at a predetermined price.
- Advantage: Provides flexibility to investors during rising interest rates.
- Disadvantage: Issuer bears the risk of premature redemption.
- Subordinated Bonds
- Description: These bonds have lower priority in the repayment hierarchy in case of issuer bankruptcy.
- Example: In the event of liquidation, holders of subordinated bonds are repaid only after senior debt holders are paid.
- Advantage: Often offer higher yields as compensation for higher risk.
- Disadvantage: Increased risk of losing principal and interest in case of issuer default.
- Perpetual Bonds
- Description: These bonds have no maturity date and pay interest indefinitely.
- Example: A perpetual bond offering a 6% coupon rate will pay interest continuously without repayment of the principal.
- Advantage: Steady income stream.
- Disadvantage: High sensitivity to interest rate changes and no repayment of principal.
- Tax-Free Bonds
- Description: Bonds where the interest income is exempt from income tax, usually issued by government entities.
- Example: Bonds issued by municipal corporations.
- Advantage: Ideal for investors in higher tax brackets.
- Disadvantage: Typically offer lower yields than taxable bonds.
- Covered Bonds
- Description: Bonds secured by a pool of assets, usually mortgages or public sector loans, which remain on the issuer’s balance sheet.
- Advantage: High credit quality due to dual recourse – the issuer and the covered pool.
- Disadvantage: Yields are often lower due to lower risk.
- Principal Protected Market Linked Debentures (PPMLDs)
- Description: These are hybrid instruments that guarantee the principal repayment while linking the returns to the performance of an underlying asset or index.
- Example: A PPMLD linked to the NIFTY index may offer returns based on its movement but assures principal protection.
- Advantage: Combines safety of principal with potential for higher returns.
- Disadvantage: Limited upside potential compared to direct equity investments.
- Capital Gain Bonds
- Description: Special bonds that allow investors to save on capital gains tax under Section 54EC of the Income Tax Act, India.
- Example: Bonds issued by institutions like NHAI and REC with a lock-in period of 5 years.
- Advantage: Tax savings on long-term capital gains.
- Disadvantage: Limited liquidity due to mandatory lock-in period.
- Bonds are generally considered lower-risk investments compared to stocks because they provide predictable income through interest payments and return the principal amount at maturity (unless the issuer defaults). However, their returns are typically lower than the potential returns from stocks.
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