Understanding Bonds

Bonds are fixed-income instruments that provide a consistent interest rate at regular intervals, along with the return of the principal amount upon maturity. Although highly sought-after in the developed world, the bond market in India has historically been relatively small. However, with the decline in interest rates for savings accounts, bonds are gaining popularity among both retail and high net worth investors.

Functionality of Bonds

Bonds can be purchased in both the primary market (at the time of issuance) and the secondary market (stock exchanges). To participate in the secondary market, a Demat account is required. Initial public offerings (IPOs) offer bonds at face value, and in the secondary market, bond prices fluctuate based on prevailing interest rates, either at a premium or discount to face value. Regular interest payments, determined by the coupon rate, are made, and the face value is returned upon maturity. Investors can also sell bonds on the secondary market before maturity.

Key Terms in Bond Investing

Understanding certain terms is crucial for effective bond investing:

• Secured/Unsecured: The authority over investment decisions lies solely with the Portfolio Manager.
• Face Value: The amount at which bonds are issued, representing the value received upon maturity.
• Coupon Rate: The periodic interest rate paid by the bond, expressed as a percentage of the face value.
• Frequency of Coupon Payments: The intervals at which interest payments are made, such as half-yearly or annually.
• Redemption Date: The maturity date of the bond, when the face value and accumulated interest are returned.
• Accrued Interest: Interest accumulated by the seller between coupon payments and the bond’s sale date.
• Yield to Maturity (YTM): The return on investment if held until maturity, considering reinvested interest payments.
• Duration: The bond’s interest rate risk, with Macaulay Duration and Modified Duration providing insights into maturity and price sensitivity to interest rate changes.
• Bond Rating: Ratings assigned by agencies like CRISIL and ICRA, indicating credit risk. Higher ratings suggest lower risk.

Types of Bonds

Several types of bonds cater to diverse investment needs:

• Corporate Bonds: Secured bonds issued by companies.
• Sovereign Gold Bonds (SGBs): Gold-backed bonds issued by RBI on behalf of the government.
• Government Securities (G-Secs): Bonds issued by RBI with a sovereign guarantee.
• Non-Convertible Debentures (NCDs): Unsecured bonds issued by companies.
• Capital Gains Bonds: Used to save capital gains tax arising from the sale of assets.

How to Invest in Bonds

Investing in bonds is similar to stocks, requiring a demat and trading account. Interested investors can contact their stockbroker for detailed information on bond investments.