Bonds In India: A Brief Handbook on 7 Types of Bonds

Overview

Bond came into the picture in 1867 but the fever started rising after 1871. No, we aren’t talking about James Bond here. 

In 1867, the bond system came into place in the Indian market, introduced to raise funds for railway construction. However, the idea gained popularity mostly in the 19th century, soon becoming the most interesting choice among investors. 

The whole scenario makes you wonder what is about it that makes it a standout choice for investors.

Well, the steady income it offers. 

But before getting too tempted, let’s get to know about it in-depth to understand basic intricacies along with merits and demerits.

What Are Bonds?

Imagine that someone asks you to borrow your piggy bank. Since you trusted the person with your money and gave permission to use the amount, they offer you back a specific interest until they return your piggy bank back.

In the world of finance, bonds act like piggy banks that have two parties, the lender and the borrower. In technical terms, the one who owns the money is known as the debtor who makes a special deal with the bondholder to pay the borrowed amount. 

The amount borrowed by the debtor is called ‘Principal’. While creating the special agreement, both bondholder and debtor agree on a maturity period in the future and agreeable interest rate, also known as ‘the coupon’, over a specific period. 

Bondholders ensure to draft a formal contract with the issuer who makes the deal of repayment with specific interest at specific periods on an annually, quarterly, or monthly basis. 

The key difference between stocks and bonds is that stockholders own the piece of equity in the company, whereas the bondholder claims the creditor stake. 

Also Read: How to Start Investing with Little Money: Smart Strategies for Beginners

7 Types of Bonds and How They Work?

Now that we are clear with the basics of bonds, let’s segregate them. On the basis of maturity period, issuer, and interest rate, bonds can be classified into different categories. But here are the seven typical types of bonds that confine different categories and make it easy to understand the concept so you can pick your strategy wisely. 

Let’s get into it without further ado:

Corporate Bonds

These loans are often issued by corporations to raise capital where they pay a fixed interest rate over a specified period. In simpler terms, if you buy a bond, you’re lending money only to the company, expecting a fat interest on your investment. Corporate bonds are riskier than government bonds but typically offer higher returns.

Government Bonds

These bonds act like rescue kits sent to the state or central government to build significant projects such as buildings, roads, schools, etc. Government bonds come under G-SEC that offer long-term investments between 5 and 40 years. If such bonds are released by the state government, they are also known as State Development Loans. It’s like putting your money in the bank, but in exchange you receive interest on the principal amount. These are considered low-risk and backed by tax and money-printing ability of the government. 

Convertible Bonds

They are a type of hybrid security bond that begins as a normal bond. But what sets it apart is chameleon behavior. Since these bonds show traits of both equity and debt financial instruments, investors get the flexibility to convert them within a predetermined time and under specific conditions. That means investors can select between the growth potential of equity and debt stability while enjoying the best of both worlds.  

Zero Coupon Bonds

Also known as discounted bonds, these are considered the rebels of the bond world. Unlike common bonds which pay periodic interest, zero coupon bonds don’t give any interest throughout the tenure and begin with a discounted price to its face value, with the difference being the investor’s return. Why an investor falls for the zero coupon bonds is the interest paid in the end, which is often higher than face value. 

Inflation-Linked Bonds

Also known as inflation-indexed bonds, these bonds’ principal value is adjusted periodically based on inflation rates. They provide protection against inflation eroding the bond’s value. The state government often issues these bonds. But the core point lies in the fluctuating interest rate. If the inflation rate goes up, the interest rate also increases, amping the value of your invested amount. The purpose is to protect the value of your investment with the inflation, by raising the percentage of benefit with the inflation rate. 

RBI Bonds

Issued by the Reserve Bank of India on behalf of the Government of India, these are mainly regulated by FRSB (Floating Rate Saving Bonds, 2020). The duration of RBI bonds is seven years and the interest rate is not fixed but changes, depending on the market conditions. FRSB is liable to alter and pay interest every six months rather than waiting for the maturity period. They offer fixed interest rates and are considered safe investments.

Sovereign Gold Bonds

It’s time to introduce the most popular bonds – Gold Bonds. These are introduced by the Central Government of India for those who want to invest in gold but do not want to stress about keeping it in its physical form. They offer an interest rate and are redeemable in cash at maturity. The best part is that there is no tax exemption and most secured bonds.

Although in some books, there are more types of bonds explained such as Callable Bonds, Mortgage-Backed Securities, High-Yield Bonds, Treasury Bonds, Municipal Bonds, and more. Every bond comes with a set of risks and rewards. It is essential for investors to fully understand the behavior of investment before making big decisions. 

Advantages & Disadvantages of Bonds

Here now let’s discuss a few merits and demerits of investing in bonds in brief:

Advantages of Bonds	Limitations of Bonds
Bonds pay you regular interest payments	If the issuer goes bankrupt, you might lose your investment
Bonds are generally safer than stocks	Bond prices can fall if interest rates rise
Bonds can provide a steady income stream for investors	Some bonds have a fixed maturity date, so your money is tied up for a specific period
Bonds can be less volatile than stocks	If you sell a bond before maturity, you might get less than you paid

Considering Bonds – Tips to Remember 

But before taking a leap for investing in bonds, there are multiple factors that an investor needs to consider. Here are a few tips to consider before investing in bonds:

• Like credit cards, bond issuers are also judged based on credit rating. The high rating leads to lower risk but may also cause lower yields. 

• Interest rate is one crucial factor before considering investment decisions. The higher the interest rates, the lower the bond price, and vice versa.

• Pay close attention to the maturity period as longer bond maturity signifies higher yields but has a more sensitive interest rate. On the contrary, with short-term bonds lower returns and low interest rate changes. 

• Investors should focus on the taxation charged on the interest rate as it may change the whole outlook of overall income.

• Akin to the definition, some bonds are more liquid and offer ease of buying and selling. On the other side, less liquid bonds are not flexible to trade and require an extended commitment. 

Via considering these factors, you can make informed decisions and begin your bond journey, or else being the detective is also an open choice, right?

Also Read: Diwali Muhurat Trading: A Blend of Tradition and Prosperity

How to Invest in Bonds in India?

Earlier, investing in bonds was a complicated and time-consuming process. Investors had limited bond options, loathing paperwork, and the least flexibility while signing up for bonds. One could either get a bond certificate or hold the bonds in their demand account which would take about or more than a week. 

However, with the ease of accessibility, technological advancement, and digitalization, the process has become extremely quick and fully paperless.

Majorly there are two major types of markets you can invest in bonds:

• Primary Market: 

In there, investors must fill out and submit a form along with relevant documents. If allotted, the bond will start showing in your demat account after the allocation date. 

• Secondary Market: 

Like any other investment, the secondary market doesn’t need you to break a leg. You can easily buy or sell your favorite bonds that are available. 

Despite this, investors can trade bonds on several other channels, including banks, post offices, mutual fund companies, online trading platforms (secondary market), etc. 

In A Nutshell

In brief, bonds are a green flag for investors and the global financial system, providing a means for corporations, governments, and other institutions to raise funds. Like every other stock, investors need to scan through the bond types, perks, and limitations to make safe and sound decisions. The process helps in developing more diverse and strong investment plans to make the most of it. Remember to take legal assistance or guidance before playing the bond game. Because once you are into it, there is no way out.