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Bonds in India

Know what is a bond, types of bonds & how to invest in them.

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5:27 min read

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Bond Meaning

There are several investment options in India and bonds are one of them. Bond is said to be a debt instrument in which the issuer company borrows money from the lender (bond holder) and, in return, is obliged to pay interest on the principle amount. The interest is called the coupon.  

The holder enters a formal contract where the issuer decides to repay borrowed money along with interest at fixed intervals, such as on a semi-annual, annual or monthly basis.

Both bonds and stocks are capital market securities; however, the difference is that stockholders have an equity stake in the company, while the bondholder has a creditor stake in the company.

It means that stockholders enjoy the status of owners and bondholders are lenders for the company. Also, bonds usually have a pre-determined interest rate and defined period or maturity, after which these are matured. Stocks, on the other hand, remain outstanding indefinitely.  

Several business owners and the Government issue bonds to raise funds for financing its long-term investments or current expenditures needs. While there are many investment options in India, bonds are considered a safe instrument because of the low risk involved in it. Lack of financial literacy and access to these markets in India often prevents people from investing in the same.

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For those looking for investment options with steady income and relatively lower risk in India, bonds can be a good option to consider.

To understand more about bonds, let us first learn about different types of bonds and how to invest in these bonds.

Different Types of Bonds that You Can Invest in India

Capital Gains Bonds

Capital Gains Bonds are those instruments that allow you to transfer your gains from long term assets such as land and house property into specific bonds.

The most significant advantage of investing in such a bond is that it offers you tax exemption from Capital Gains Tax under Section 54EC of the Income Tax Act, 1961, for up to 6 months from the sale of the asset sold.

It means that an individual need to invest in capital gains bonds within 6 months from the transfer of capital assets.

Bonds eligible under Section 54EC of the Income Tax Act, 1961 are issued by:

  • NHAI (National Highways Authority of India)
  • RECL (Rural Electrification Corporation Ltd)
     

Government Securities

Bonds issued by the Central and State Governments are called Government security. Since these are issued by Governments they carry no credit risk. These are one of the safest types of investment options in India to earn periodic interests and principal on maturity. These bonds pay interest on semi-annual basis.

Corporate Bonds

These are bonds issued by various corporates for their financing needs and hence carry credit risk. The holder of the bonds earns regular interest income. and principal amount at maturity. Corporate bonds pay higher interest than Bank FD’s and Government bonds.

Inflation-Linked Bonds

In such type of bond, both principal amount and interest payments are indexed to inflation. Inflation indexed bonds are an efficient way to counter the inflation risk.

Convertible Bonds

This kind of bond allows its holder the option to convert it into equity based on pre-specified terms.

Sovereign Gold Bond

The Government of India also issues sovereign Gold Bonds. Gold bonds are in form of a security as it in the form of the Government of India stock. It also carries interest rate which is paid regularly and has zero risk of handling that exists in physical gold.

RBI Bond

The Government of India decided to issue 7.75% Taxable Bonds, 2018, with effect from January 10, 2018 [2], for enabling resident citizens/HUF to invest in a taxable bond, without any monetary ceiling.

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The Government of India also issues sovereign Gold Bonds. Gold bonds are in form of a security as it in the form of the Government of India stock. It also carries interest rate which is paid regularly and has zero risk of handling that exists in physical gold.

RBI Bond

The Government of India decided to issue 7.75% Taxable Bonds, 2018, with effect from January 10, 2018 [2], for enabling resident citizens/HUF to invest in a taxable bond, without any monetary ceiling.

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Is it difficult to invest in bonds as compared to equity shares?

While there are several types of investment options in India, bonds and shares are the two most widely followed asset types. Investment in bonds can be done via primary or secondary market. In primary market, one can subscribe to the public issue of large companies. Alternatively, one can purchase bonds from secondary market being traded on exchanges.

Usually, bonds are considered to be illiquid are kept till the maturity. However, if you need to pre-maturely exit the investment, one can sell it in the secondary market.

In the case of a bond, the holder is dependent on the issuer for getting back the lent money. Therefore, it is vital to check the credit-worthiness of the issuer.

As a purchaser of bond, one should buy bonds or debentures issued by a good-quality issuer.  

The way to ascertain the quality of the issuer is to look at their credit rating. 

Credit rating agencies provides ratings for the issuer with an opinion on the credit-worthiness of issuers. Companies rated AAA (triple A) are perceived to be high quality issuer. Professional investors, like fund managers and corporate treasury managers, conduct their research about the fundamental quality of the issuer.

However, since every investor may not have the bandwidth to do so, it is advisable to check it through credit rating agencies. 

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The way to ascertain the quality of the issuer is to look at their credit rating. 

Credit rating agencies provides ratings for the issuer with an opinion on the credit-worthiness of issuers. Companies rated AAA (triple A) are perceived to be high quality issuer. Professional investors, like fund managers and corporate treasury managers, conduct their research about the fundamental quality of the issuer.

However, since every investor may not have the bandwidth to do so, it is advisable to check it through credit rating agencies. 

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What Returns can I expect from investments into Bonds?

Bonds carry coupon or interest rate, which is usually payable every year and is defined as a percentage of the bond’s face value. The interest rate on a bond is defined at the time when the company or the Government issues you the bond. For example, if its face value is Rs. 100, and the coupon/interest rate is 7%, you will get Rs. 7 every year.

When you buy a bond from the primary market, it is mostly issued at face value, and the return is the same as the coupon/interest rate. However, if the purchase is made in the secondary market, depending on the price being lower or higher than the face value, the return will also be a little higher or lower than the interest rate. This return is defined by a measure called Yield to Maturity (YTM) which is one of the most common measure of returns in bonds

Will you always get a fixed return on a bond?

If you hold these bonds till maturity, then you will get a fixed return on your invested money. But if you sell the bond prematurely, its price will depend on market conditions prevailing at that time. If your sale price is higher than your purchase price, your return will also be higher accordingly and vice versa.

However, the bond market is less liquid than the equity market, meaning you may not get the best price if you want to sell it before maturity. 

Should you consider diversification?

It is also advisable to consider diversification when putting your funds in any of the available investment options in India. The same is the case when buying bonds. You may invest in different types of bonds for further reducing or eliminating non-systemic risk. The various ways of diversification are as follows:

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Should you consider diversification?

It is also advisable to consider diversification when putting your funds in any of the available investment options in India. The same is the case when buying bonds. You may invest in different types of bonds for further reducing or eliminating non-systemic risk. The various ways of diversification are as follows:

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It is also advisable to consider diversification when putting your funds in any of the available investment options in India. The same is the case when buying bonds. You may invest in different types of bonds for further reducing or eliminating non-systemic risk. The various ways of diversification are as follows:

Investing in Bonds of Varying Quality

One can invest in high quality AAA rated bonds or lower rated papers depending on risk tolerance of each investor. Generally, highest quality AAA rated companies carry interest rates higher than those provide by bank FDs. Lower rated bonds carry higher risk and hence provide higher yields to compensate the investor for the higher risks.

You can consider investments under Section 80C, such as infrastructure bonds or tax free bonds, which will make you eligible to claim tax deductions.

Investing in Bonds with Different Maturity Dates

One can invest in short--term bonds like Certificate of deposits or commercial papers having maturity less than one year.  For longer investment horizon one can invest in Government bonds or bonds issued by corporates.

Investing in Geographically Diverse Bonds

When considering different investment options in India, you may even consider diversifying your bonds between different regions in the country or nations. It will help limit your risk by insulating you against price fluctuations in the different areas while remaining invested in the best investment options in India.

Investment in Debt Mutual Funds

One can take exposure to debt market via Debt Mutual funds too. There are various types of debt schemes offered by Mutual Funds suitable to different types of investors. These schemes range from overnight funds for very short-term investments to longer duration funds. There are also credit funds which give an option to investors to invest in lower rated corporate papers.

Consider the Best Investment Plans in India

The financial literacy about these products in India is still low, and that is why many people have apprehensions about the available investment options in India, especially bonds.

However, when looking for the best investment plan with assured returns, you can consider buying the best bonds, as they have relatively less associated risk than equity funds. With both maturity return and regular interest payment, you can generate a steady and secure income from bonds.  

Depending on your needs, you may choose from a variety of investment options in India, such as Unit Linked Insurance Plans (ULIPs) and Government, callable or convertible bonds. You can search for different investment options in India and see which one aligns best with your needs.

Consider different types of investment options in India and buy the best investment plan. For example, when you invest in ULIPs, you can avail of a combination of investment and insurance. In other words, ULIP investments provide you equity and debt fund investments, similar to bond options, while securing your loved ones with an insurance cover.  

Sources:

[1]https://www.incometaxindia.gov.in/Acts/Finance%20Acts/2000/102120000000009405.htm

[2]https://www.rbi.org.in/Scripts/NotificationUser.aspx?Id=11196&Mode=0

[3]https://www.sebi.gov.in/sebi_data/attachdocs/1288587929503.pdf

ARN: June/Bg/11

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