'Bond' - A Debt Investment Avenue For Risk Averse Investors
Written on Thursday, May 11, 2017
By Shikha Bhatnagar - Executive Vice President, private banking, Bajaj Capital.
A businessman to his fat wife "you are the only investment that has doubled."
Perhaps that businessman is yet to explore the right investment avenues, otherwise, he would have a long list of rewarding investments to count upon, for instance, he can pick up 'Bonds.' Why Bonds? Because it is that investment avenue, where an investor earns by lending money to governmental or/and corporate entities. So, it is a debt investment and normally seen as a safe investment with no lock-in period. The income from certain bonds is tax-free as well.
What are 'Bonds'?
A bond is a debt investment in which an investor loans money to an entity (typically governmental or corporate) which borrows the funds for a defined period of time at a variable or fixed interest rate.
Bonds are issued by companies and governments.
Owners of bonds are debt-holders or creditors of the issuer.
How Do Bonds Work?
When companies or other entities need to raise money to finance new projects, maintain ongoing operations, or refinance existing other debts, they may issue bonds directly to investors instead of obtaining loans from a bank. The indebted entity (issuer) issues a bond that contractually states the interest rate (coupon) that will be paid and the time at which the loaned funds (bond principal) must be returned (maturity date).
The issuance price of a bond is typically set at par, usually Rs.100 or Rs.1,000 face value per individual bond. The actual market price of a bond depends on a number of factors including the credit quality of the issuer, the length of time until expiration, and the coupon rate compared to the general interest rate environment at the time.
Most bonds share some common basic characteristics including:
Face value is the money amount the bond will be worth at its maturity and is also the reference amount the bond issuer uses when calculating interest payments.
Issue price is the price at which the bond issuer originally sells the bonds.
The coupon rate is the rate of interest the bond issuer will pay on the face value of the bond, expressed as a percentage.
Coupon dates are the dates on which the bond issuer will make interest payments. Typical intervals are annual or semi-annual coupon payments.
The maturity date is the date on which the bond will mature and the bond issuer will pay the bond holder the face value of the bond.
Major Types of Bonds
1. GOVERNMENT BONDS : A government bond is a bond issued by a national government, generally with a promise to pay periodic interest payments and to repay the face value on the maturity date or payment cumulatively at the maturity date. Government bonds are usually denominated in the country's own currency. Government bonds are sometimes referred to as "sovereign bonds".
The biggest advantage of Government bonds is safety and security followed by fixed rates and liquidity.
2. TAX-FREE BONDS : Tax-free bonds have emerged as highly popular investment option among investors due to the taxation benefit that they offer. These bonds, generally issued by Government-backed entities, are exempt from taxation on the interest income received from such instruments under the Income Tax Act, 1961.
Features and Advantages Of Tax-Free Bonds :
1. Tenure: Choice of 10 years, 15years & 20 years
2. Such bonds are likely to be listed on NSE / BSE
3. No lock-in period
4. Normally seen as a safe investment.
5. Could be held either in Demat or Physical form
6. Tax-Free Income
7. Low risk, since companies have a better credit rating
8. Listing of bonds on exchanges provides liquidity
3. RBI BONDS : RBI bonds refer to the bonds issued by Reserve Bank of India. The money raised may be used to finance its various projects like long-term lending, development of the economy etc.
Bonds issued by RBI : 8% saving bond and sovereign gold bond
4. CORPORATE BONDS : A corporate bond is a debt security issued by a corporation and sold to investors.The backing for the bond is usually the payment ability of the company, which is typically money to be earned from future operations. In some cases, the company's physical assets may be used as collateral for bonds.
Corporate bonds are considered to have a higher risk than government bonds. As a result, interest rates are almost always higher on corporate bonds, even for companies with top-flight credit quality. For example, in today’s date , 5 year G-Sec is available at a yield of 6.97% and 5 year AAA corporate bond is available at a yield of 7.44%.
The biggest advantage of a corporate bond is that it provides strong returns, higher liquidity.
"Do not save what is left after spending, but spend what is left after saving." This quote by Warren Buffet illustrates the concept of 'paying yourself first.' The concept has always worked brilliantly in favor of investors as it helped them in inculcating the habit of regular saving and investing.