What Is A Bond And How Does It Work?

When investment is considered, the first thing to cross minds is a stock market investment. The stock market is indeed an exciting platform to gain higher returns, but when it comes to safety, this appeal is not the same. To that end, bonds are an ideal investment instrument. However, many do not consider them, and bonds themselves are little known to many. 

Bonds are known for their high security and risk-free investment benefits, and many investors opt for them to dilute the risk in their portfolio. Moreover, it’s easier to invest in bonds now with online platforms, which feature several bond investment options from various issuers. 

What Are Bonds?

A bond is a debt instrument issued by the Government of India and authorised companies to raise funds for a specific tenure. An issuer owes a bondholder a particular debt and repays the principal at maturity. The issuer pays the investor interest payments throughout the term, usually twice a year. It is like an IOU between borrowers and lenders, which specifies the loans’ details, principal, and interest payments. 

At the term’s end, an investor receives the bond value and a coupon (pre-stated rate of interest). Akin to stock investments, bondholders can sell bonds any time within the maturity period. 

How Do Bonds Work?

Investment bonds, also known as fixed-income securities, are one of the three asset classes and cash equivalents and equities (stocks). 

While most government and corporate bonds are traded publicly, several others are traded Over-The-Counter (OTC), privately between the investor and the issuer, and even via online platforms. 

• GOI or companies issue bonds to raise funds for new projects, be it for infrastructural development purposes or carrying out business operations. 
• An issued bond comes with a specific maturity date and interest payments (coupon) that will be made against the bond value.
• Every bond has a face value. However, their market value can vary.
• The actual market price of any bond depends on several factors like the issuer’s credit rating, maturity period, and interest rate.
• Investors earn a return against the bond, also known as yield, which is the interest payment divided by the bond’s par value. 
• The yield of any bond is inversely proportional to bond price – bond prices dip if market interest rates go up and vice versa. 
• Even though the market price of bonds is subject to fluctuations, its face value remains constant. 
• A bond with a poor credit rating delivers higher returns since there’s more risk involved. 
• A bond with a longer maturity period offers higher coupon payments because of the associated inflation risk.
• Bondholders also have the option to sell their bonds to other investors before they mature.
• Likewise, borrowers can repurchase the bonds if interest rates have lowered or the borrower’s credit rating has improved. 

Types Of Bonds 

• Government Bonds

As the name suggests, these bonds are directly issued by the Government of India. Government bonds are risk-free investment schemes as the Indian government backs the returns. When the government requires finance to fund infrastructural development projects and other government expenditures, such bonds are issued under RBI’s supervision. These bonds are long-term investment instruments ranging from 5 years to 40 years. 

• Corporate Bonds

These bonds are open-ended debt instruments issued by an authorised company to fund their ongoing business operations, expansion plans, clear previous debts, or meet other business requirements. Debt bonds are safer than equity shares since the bondholder is obligated to repay the invested sum along with periodic interest payments. People can invest in these bonds along with digital gold and PMS via online platforms.

• Municipal Bonds

Issued by the Urban Local Bodies (ULB) and state municipal corporations, muni bonds or municipal bonds are debt obligations to obtain finance for social and economic infrastructural development projects such as constructing bridges, hospitals, educational institutions, public facility centres, or urbanise a specific region. The ULB repays individual investors from the capital generated by such projects or tax revenue. Interests from muni bonds are exempted from taxes in most cases. 

Wondering Why Invest in Bonds? Read To Know!

Investing in bonds provides investors with a fixed and secured source of income. Investors receive the entire principal at the end of the maturity period, and, therefore, is the best way to secure capital and utilise idle funds. 

Also, tax-free investment bonds are incredibly profitable for investors, wherein the principal and interest payments are not liable for income tax. Such bonds are the best investment options for retail investors belonging to a higher tax bracket.

Bottom Line

Bonds investment involve minimal risk since these are backed by either a government body or authorised companies. The chances of a government body defaulting is marginal, while corporate bonds offer higher returns. Investors looking for the best bond can invest via reliable online platforms for an end-to-end solution.