Bonds And Types Of Bonds
The government, as well as corporate entities, require funding to meet various expenses. Whether it’s socio-economic infrastructural development projects or business operations, external funds play a crucial role in carrying out the works.
While companies can issue new equity shares to that end, the government can sell its state-owned institutions to gather funds. An alternative option of raising finance without selling or staking any asset is by issuing fixed-income securities such as bonds.
What Are Bonds?
Bonds are debt instruments issued by any entity to raise finance from potential investors and the society at large. Akin to loans, bonds come with a maturity period. It is essentially an agreement between a borrower/issuer and investor.
They are investment instruments in which the entity borrows finance from an investor (lender), and in return, pays interest (coupon) against the bond’s face value (principal amount) for a specified period (maturity term). Governments, municipalities, companies and other independent financial institutions issue bonds. Like securities, one can easily trade in this via stock exchanges, platforms.
In simple words, investors can purchase bonds to lend funds to the issuer, GOI, a governmental or civic body, a corporation, or any other entities. The issuer, in return, is obliged to pay interest at a specified rate during the term period.
Types Of Bonds To Look Out For
There are several types of bonds available in the Indian market catering to different investors’ needs.
Government bonds are debt instruments issued by the Central and state governments to fund various infrastructural development projects. GOI issues such bonds under the Reserve Bank of India’s supervision. It repays the principal at the maturity period along with interest payments, either semi-annually or annually, as specified. Investors can choose from different government bonds such as floating-rate bonds, fixed-rate bonds, Sovereign Gold Bonds (SGBs), Inflation-indexed Bonds (IIBs), etc.
Municipal Bonds are debt instruments that Urban Local Bodies (ULB) and municipalities issue to raise funds from investors. Muni bonds are raised to finance socio-economic developmental projects like building bridges, hospitals, educational institutes, public facilities, or urbanisation of specific regions within the issuing state. Issuers pay returns from profits generated by such projects or tax revenues. There are two municipal bond types – Revenue Bonds and General Obligation Bonds (GO).
These bonds are debt instruments issued by a company to raise capital for their daily operations, purchasing new machinery, expansion plans, and growth opportunities. Essentially, the company owes money to debtholders and are legally preferred over shareholders when it comes to offering returns. It repays the principal when the bond matures, as agreed upon. Bondholders, in return, receive interest periodically as per the predetermined rate.
Apprehensive Regarding Bond Investment? Read To Clear The Doubts
- Fixed Income Source – Even though the income generated by stocks is higher, bonds are less risky investment options, offering a fixed and stable income source. Investors can be assured of steady and fixed interest earnings over a long tenure with bonds.
- Capital Preservation – Issuers of bonds are obliged to repay the bond’s face value after the maturity period along with interest payments at a specific rate. With such an obligation of repayment, there is a marginal risk of running a loss.
- Tax Benefits – One of the significant benefits of bonds is their tax-free feature. There are several tax-free bonds available in the market. Retail investors falling under a higher tax bracket can purchase such bonds to minimise their tax outgo.
- Risk-free investment – Bonds issued by GOI are risk-free investments. Although the yields from such bonds are not as high as in equity shares, the principal is not at risk. Investors will assuredly realise their invested amount on maturity along with periodic returns. The fact that the government backs these bonds makes it all the more risk-free, as there is only a marginal chance of default.
- Easy Portfolio Diversification – In recent times, many online platforms are providing such bonds. Investors can now buy bonds online from the comfort of their home and optimise their investment portfolio. Since the face value of bonds remains unaffected by market fluctuations, investing in such bonds allows investors to cope with market dips easily.
India’s bond market offers high liquidity and various secured investment avenues for investors to explore. Bonds investment is perhaps one of the more lucrative options for risk-averse people who prefer capital preservation over aggressive returns. Nonetheless, it’s essential to be equipped with the ins and outs of this market, the types available – government, corporate, and muni – to make an informed choice.