What is a Bond in Finance? Everything You Need to Know

A bond is a type of security issued for a loan to corporate or government entities at a fixed interest rate for a certain period. The bond, also called a fixed income instrument, offers lower risk than stock and better return than FD. Bond investment doesn’t give you ownership like stocks but allows you to lend money typically to companies, municipalities, states, and sovereign governments to finance their projects or operations. When the bond matures, the borrowers of your bond repay the principal amount with interest. You must know the bond value changes over time according to the market.

In this blog, we will discuss bonds in detail, including their definition, who issues them, their importance, types, characteristics, and more. 

Let’s dive deeper into the piece to learn about bonds in detail!

What are Bonds? 

Bonds are debt security that a company or government body issues to raise funds.  An individual who wants to lend money or invest for a short/long term at a fixed rate can consider buying bonds. The profit and loss of the bond are more predictable than the stocks. Bonds lets you diversify your portfolio with generated interest. 

Who Issues the Bond?

The issuers of bonds in India are: 

• Government 

State or central government issues bonds to raise funds from the public to build roads, dams, schools, and other infrastructure projects. Individuals can buy these bonds and earn through the fixed interest rate. 

• Corporate ‍

Companies that expand their business, acquire new equipment, or undertake profitable projects need more money than a bank can lend. Through bonds, the company raises funds with the help of the general public and repays them with interest.   

Importance of Bonds in Economy 

Bonds play a significant role in the Indian economy by allowing corporations and governments to borrow large sums of money at lower interest rates and invest them in profitable projects. Unlike loans, bonds don't buy a company in any terms or conditions and freely invest the amount for the company's growth opportunities. 

Besides the company's benefits, bonds also allow investors to preserve their principal and earn interest by supporting the development of projects and companies. This creates a steady source of income for individuals from before maturity. 

Types of Bonds in Finance 

1)Government Bonds 

Government bonds are referred to as those bonds issued by the government. This government can have multiple variations:

i) Treasury Bond 

The central government issues treasury bonds, which are considered the safest investments. The treasury bonds don’t involve any risk. However, treasury bonds have a maturity period of ten to thirty years and pay a fixed interest rate. 

ii) Municipal Bond 

Also called munis, municipal bonds are issued by state governments, municipalities, or local governments. Municipal bonds are highly risky compared to treasury bonds. However, they are exempt from tax and available for long-term and short-term bond investments. 

2)Corporate Bonds 

Companies issue corporate bonds and are at higher risk than government bonds. These bonds are taxable. However, these bonds include varying maturities and interest rates depending on the issuers' creditworthiness and market conditions. The variations of corporate bonds are:

i) High-yield bonds 

Corporations issue high-yield bonds, also called junk bonds, that provide higher profits. However, these bonds also include high risks. 

ii) Investment grade bond 

Unlike high-yield bonds, investment-grade bonds are believed to have lower risks and low yields. Credit rating agencies give investment-grade bonds high ratings. 

iii) Convertible bond 

This is one of the types of bonds issued by companies that can be converted into stocks. The convertible bond offers a low yield and the opportunity to own the company instead of staying a lender. 

iv) Zero Coupon bond 

Zero accrual bond that doesn't make interest payments but pays the entire principal amount along with the compounding semi-annually interests. The zero coupon bonds, also known as accrual bonds, are offered at discounted rates. 

3)Sovereign Gold Bonds 

RBI issues sovereign gold bonds that allow individuals to invest in gold without buying the gold in physical form. The SGBs hold a fixed maturity period of 8 years and offer a fixed interest rate of 2.5%. 

4)Floating Rate Bond 

Floating rate bonds refer to bonds offered by corporations whose interest rate is subject to market. These bonds adjust interest rates periodically per the reference rate, such as RBI’s repo rate. 

5)Inflation Protected Bond 

The government issues Inflation-protected bonds, which adjusts interest rates periodically to match the inflation rate. 

How do bonds work?

A company or organisation issues bonds to raise funds for projects and businesses. Individuals or investors after checking the bond’s credit quality, potential profits, and other benefits  buy those bonds. When the investors buy those bonds it means they are lending money to the organisation. 

The bond is treated like a loan and repays the interest on a fixed date and the principal after maturity. 

Bonds help both individual investors and organisations. As the interest of loans are comparatively lower than loan in bond, Moreover, through funds companies can generate huge funds. 

Characteristics of Bonds

Now that you know about the different types of bonds. Let’s understand the various terminology used in these bonds to gain a better understanding of these financial instruments. 

Face value or Par Value

Face value refers to the price of a single bond at which individuals buy it, and the issuer is obliged to return it after its maturity along with the interest. The face value is also called par value or principal value. 

Coupon Rate

Coupon rates, also called interest rates, imply the fixed or floating interest rates on bonds. The coupon rate can vary depending on the number of factors such as tenure, the issuer’s reputation in the public debt market/ 

Coupon Dates

The coupon date is when the bond issuer will make interest payments to you. 

Maturity Date

The date on which the bond will mature and the bond issuer will pay the bondholder the face value of the bond.

Credit Quality 

The credit quality of a bond refers to the degree of confidence that investors have in a bond issued by an organisation. The credit quality signifies the risk associated with it. 

Advantages of Bonds

Advantages of Bonds

• Steady Income 
• Low Risk
• Portfolio diversification
• Tax exemption 
•  Options 

Bonds offer several advantages to investors and allow them to build a 360-degree financial portfolio. Here are some key benefits of bonds: 

1. Steady Income 

Bonds provide a reliable source of income through regular interest payments, known as coupon payments. This steady income stream can provide a sense of security, especially if you opt for a bond that offers a fixed coupon rate. 

2. Low Risk 

Compared to stocks, bonds are considered less volatile. Since, in the case of company liquidation, bondholders have a higher claim on assets. 

3. Portfolio Diversification 

Another benefit of bonds is that they allow you to diversify your portfolio. By investing in bonds, you can balance the risk associated with your investment in stocks. 

4. Tax exemption 

Some types of bonds, such as municipal bonds, offer tax exemption.  This is the best investment plan for individuals with higher tax brackets. 

5. Various Options 

Various bond options are available to choose from, like corporate and government. These bonds have different risks, tenure, and interest rates, offering investment options. 

How to Buy Bonds?

You can buy bonds directly from the bond issuer, financial advisor, stock broker, or any stock broking platform offering the bond investment options. GoPocket, an online brokerage platform, will soon provide bond investment options for individuals looking for steady income, portfolio diversification opportunities, lower-risk investment and more. 

GoPocket is the online face of Sky Commodities India Private Limited, one of the well-known stock brokerage companies in India. With its physical office at 25+ locations and a legacy of 30+ years, it is one of India's leading online brokerage platforms. With it, you can invest in stocks, mutual funds, IPOs, commodities, futures, and options. Soon, the app will be equipped with a feature to buy stocks. 

What is the difference between bond and loan?

Bonds and loans help businesses raise funds for upcoming projects and business growth. Here’re some differences between them. 

Recent Change in Bond Market  

SEBI (Securities and Exchange Board of India) has given the go-ahead to its proposal of a minimum ticket size of bond investment of Rs 10,000/-. The minimum ticket size was from its existing investment amount of Rs. 1 Lakhs. The move is crucial to reform the bond market.  This will increase retail participation in the bond market. This will help companies to raise funds from several available sources. 

Conclusion

Bonds are debt security and a great option, especially for individuals looking for better returns than FD and lower risk than stocks. Bonds offer flexibility to choose from several options, such as opening a steady income source, saving tax, and diversifying your portfolio. However, you must do market research for bond investments, which is also essential. Ensure that you read about the company, terms and conditions, the purpose of the bond, bond types and more. 

GoPocket will soon integrate options for seamless bond investments. Until then, open your demat account with GoPocket and invest in the stock market, mutual funds, commodities, and more. 

FAQs Related to Bonds 

1. Why are bonds an asset?

A bond is called an asset because it gets exchanged in the financial market whether in physical and electronic format. Moreover, the value of these bonds also changes with market fluctuation. 

2. Why invest bonds?

Some key benefits of investing in bonds are fixed income, tax exemptions, low risk etc.

‍