Exploring Different Types Of Bonds: A Complete Guide

Bonds provide a secure way to save and invest money while powering economic growth. But bonds are not just about finances. They also tell stories about moments in history when the government or companies needed to borrow money for big projects. From government bonds to corporate bonds, there are various bonds in the Indian market for investors intending to diversify their portfolios.

Bonds are debt investments, commonly referred to as fixed-income securities. It involves lending money to an entity (typically corporate or government). The borrower uses the funds for their operations. They return the money at fixed intervals according to a pre-defined interest rate. Bonds are one of the three main asset classes, along with stocks and cash equivalents.

Bonds can provide stability for investors looking for steady income, such as retirees or those looking for long-term growth opportunities. Bond issuers, governments and corporations can use money from bonds to finance their operations, making them an attractive investment option for many investors.

In this article, let’s look at the different types of bonds available for investors in India. We will also discuss their features and advantages to help you decide the best bonds to invest in India.

Different Types Of Bonds

Bonds are a popular investment option for those looking for a predictable income without taking too much risk. There are several types of bonds in India, each with its own unique characteristics and risk profiles. Understanding the different types of bonds is essential for investors to make informed decisions and diversify their portfolios.

The different types of bonds can be better understood if we classify them on the basis of issuer and yield. Let’s look at different types of bonds on these parameters:

The Types Of Bonds On The Basis Of Issuer

1. Government Bonds

Government bonds, also known as sovereign bonds, are issued by national governments to fund their operations and pay off debt.

These bonds are considered one of the safest investments available because of the full faith and credit of the government backing. As a result, they typically have lower interest rates than other types of bonds, but they offer a low-risk option for investors who prioritise capital preservation over high returns. Government bonds can be issued in different maturities ranging from short-term Treasury bills to long-term Treasury bonds. Overall, government bonds provide investors with a stable source of income while reducing portfolio risk through diversification.

2. Corporate Bonds

Corporate bonds are a type of debt security companies issue to raise capital to finance their expansion, acquire assets, or refinance existing debt. These bonds typically have a fixed interest rate and maturity date, making them a popular investment option for those looking for steady income. 

Investors buy corporate bonds in exchange for the promise of regular payments and a return on their investment when the bond matures. Credit rating agencies typically rate corporate bonds. A higher bond rating lowers the risk of default and increases investor confidence.

Corporate bonds can vary in risk depending on the financial health of the company issuing them. For example, investors may lose some or all of their investment if a company defaults on debt payments. As a result, investors must conduct due diligence and research before investing to understand the potential risks. Overall, corporate bonds are fixed-income bonds that offer investors an opportunity to earn fixed income while diversifying their portfolio beyond stocks and government bonds.

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3. Municipal Bonds

Municipal bonds are debt securities issued by governments and various government agencies. These bonds are used to finance a wide range of public infrastructure projects such as schools, highways, bridges, water treatment facilities, and more. 

Municipal bonds offer tax advantages for investors because their interest income is often tax exempted. However, Municipal bonds carry more risk than government bonds due to the financial health of the issuing municipality or agency.

Investors should carefully evaluate the issuer's creditworthiness before investing in municipal bonds. Overall, municipal bonds provide a way for investors to support public projects while earning tax-advantaged income.

4. Convertible Bonds

Convertible bonds are a type of debt security that can be converted into a predetermined number of shares of the issuer's common stock at the bondholder's discretion. The feature gives convertible bonds a hybrid nature, combining debt and equity securities. 

Convertible bonds typically offer lower interest rates than traditional bonds because of their conversion feature. The underlying stock price and interest rates influence the value of convertible bonds. 

If the stock price rises above the conversion price, bondholders may convert their bonds into shares, which could result in capital gains if the stock continues to rise. However, if the stock price falls below the conversion price, bondholders may choose to hold onto their bonds and receive periodic interest payments. Overall, convertible bonds provide investors with flexibility and the potential for higher returns than traditional bonds while still offering downside protection through fixed-income payments.

The Types Of Bonds On The Basis Of Yield

1. High-Yield Bonds

High-yield bonds, as the name suggests, offer comparatively higher returns. High-yield bonds are bonds that pay higher interest rates to make up for lower credit ratings in comparison to investment-grade bonds and for the higher risk of default. Due to their low credit ratings, high-yield bonds are also known as junk bonds. However, there are some high-yield bonds which are investment grade as well. These bonds are rated BBB or BBB+ and they offer fixed returns of up to 14%. The bonds rated below BBB are considered as Junk bonds and investors should avoid these bonds.

2. Floating Rate Bonds

Floating-rate bonds are bonds that pay interest based on a variable rate that adjusts periodically. This is the reason why these bonds are also called variable or adjustable rate bonds.  This rate is typically linked to a benchmark interest rate, such as the Consumer Price Index (CPI), the Mumbai Interbank Offered Rate (MIBOR), or the RBI's repo rate. The interest rate is adjusted at fixed intervals, such as quarterly or half-yearly.  This means that the interest payments on these bonds will fluctuate with changes in the benchmark rate, providing investors with some protection when interest rates are rising because the interest payments increase with the benchmark rate.

3. Zero-Coupon Bonds

A zero coupon bond, also known as a discount bond or accrual bond, is a debt instrument that does not pay interest during its term. Instead, the bond is sold at a discount to its face value, and the investor receives the full face value when the bond matures. Unlike regular bonds, these bonds do not offer periodic interest payments or coupons, hence the term zero-coupon bond. The investor's profit is the difference between the purchase price and the face value. Zero-coupon bonds guarantee a lumpsum return at the end of the maturity period.

4. Callable Bonds

A callable bond, also known as a redeemable bond, is a bond that the issuer can redeem before it reaches its maturity date. This means the issuer can pay back the principal to the investor before the bond's scheduled maturity date. While all other attributes are similar to other bonds, these bonds come with a call option, meaning the issuer can redeem the bonds before the maturity period. From an investor’s perspective, there is uncertainty as to whether the bond will keep paying regular interest till maturity since the issuer may or may not choose to redeem the bonds before maturity term. Call price is the price at which the issuer can redeem the bond, which is usually the face value of the bond plus a call premium.

5. Inflation-Protected Bonds

As the name suggests, these bonds are designed to protect investors against inflation or to offer a hedge against inflation. These bonds are also known as inflation-indexed bonds or linkers. Inflation-protected bonds are indexed to inflation, so the principal investment, as well as the interest offered both rise and fall with the inflation rate. This adjustment ensures that the bond's value keeps pace with rising prices, preserving the purchasing power of the investment. Because inflation-protected bonds offer protection against inflation, they typically have lower interest rates than conventional bonds.

Features, Characteristics And Advantages Of Different Types Of Bonds

1. Government Bonds 

Government bonds are debt securities issued by national governments to raise capital. 

Features

• Government bonds have a fixed maturity date on which the issuer will repay the principal amount to investors.
• They pay a fixed rate of interest (also known as coupon rate) to investors at regular intervals until maturity.
• Government bonds are less risky than corporate or municipal bonds.

Characteristics

• The creditworthiness of the issuing government affects the risk level of government bonds. A high credit rating indicates lower risk, while a low credit rating indicates higher risk.
• Some government bonds may be inflation-indexed, meaning their interest payments and principal value are adjusted for inflation.

Advantages

• Government bonds offer investors a safe haven during economic uncertainty or market volatility.
• Investing in government bonds provides diversification benefits for portfolios that are heavily invested in stocks or other asset classes.
• Some government bonds may offer tax-exempt status if they are issued by certain types of governments or used for specific purposes.

2. Corporate Bonds

Corporate bonds are debt securities issued by corporations to raise capital for their business operations.

Features

• Corporate bonds also have a fixed maturity date. The issuer repays the principal amount, also known as the Par Value, to investors on the pre-defined maturity date.
• Investors earn interest called coupon amounts or normal yield. 
• The issuer pays the coupon amount at a fixed rate of interest, also known as the coupon rate, and at regular intervals until maturity.
• Corporate bonds can be traded in the secondary market before maturity.

Characteristics

• Corporate bonds are typically issued for a period of 5 to 10 years with an option for early redemption after 3 to 7 years, depending on the issuer.
• The creditworthiness of the issuing corporation affects the risk level of corporate bonds. A high credit rating indicates lower risk, while a low credit rating indicates higher risk.
• Some corporate bonds may be callable, meaning that the issuer has the right to redeem them before maturity.
• Investors can buy corporate bonds in India through primary markets, where they are directly issued by companies, or secondary markets, where existing investors trade them among themselves.

Advantages

• Corporate bonds offer higher yields than government bonds due to their higher risk profile. This makes them attractive to income-seeking investors.
• Investing in corporate bonds can provide diversification benefits for portfolios that are heavily invested in stocks or other asset classes.
• Some corporate bonds may be eligible for tax-exempt status if they are issued by certain types of corporations or used for specific purposes.

Government Bonds Vs. Corporate Bonds

When comparing government bonds to corporate bonds, there are several differences in how they perform. Government bond yields tend to be lower than corporate bond yields because they carry less risk. However, this also means that their returns may not keep pace with inflation over time. Corporate bond yields tend to be higher due to their higher risk profile but may also be more volatile.

In terms of creditworthiness, governments generally have higher credit ratings than corporations due to their ability to issue currency and collect taxes. This makes government bonds less likely to default than corporate bonds. Overall, government bonds are suitable for investors looking for low-risk and moderate returns on their investments.

The table below summarises the key differences between government bonds and corporate bonds:

3. Municipal Bonds

Municipal bonds are debt instruments issued by local government authorities and agencies to finance public infrastructure projects and other civic activities, such as water supply, sewerage systems, road construction, airports, railways, and housing facilities.

Features

• Municipal bonds have a fixed maturity date on which the issuing municipal authority will repay the principal amount to investors.
• The coupon rate is a fixed rate of interest on which the interest is paid to investors at regular intervals until maturity.
• Municipal bond interest is typically exempt from income tax and may also be exempt from taxes for investors.

Characteristics

• Municipal bonds in India have a fixed maturity period that can range from three years to thirty years.
• The net worth of the Municipal body issuing the bonds shall not be negative in the preceding three years.
• The creditworthiness of the issuing municipality affects the risk level of municipal bonds. 
• Bond prices may fluctuate in the secondary market based on the municipality’s financial performance.

Advantages

• Investing in municipal bonds can provide tax benefits for investors in high tax brackets.
• Municipal bonds offer diversification benefits for portfolios that are heavily invested in stocks or other high-risk asset classes.
• Some municipal bonds used to finance specific projects such as schools, hospitals, or infrastructure development may generate higher yields than others.

In summary, municipal bonds can provide investors with potential tax advantages while also offering diversification benefits and supporting community development. However, interest rates on these bonds are lower than those offered on corporate bonds or government securities due to their comparatively low credit risk.

4. Convertible Bonds

Convertible bonds are hybrid corporate debt securities that have features of both bonds and stocks.

Features

• Convertible bonds combine the features of debt and equity instruments.
• They offer investors both fixed-income returns through coupon payments, as well as potentially higher gains if converted into shares at predetermined terms.

Characteristics

• Convertible bonds can be converted into a predetermined number of shares of the issuer's common stock at the holder's dispense. The conversion ratio determines the number of shares the bondholder will receive upon conversion.
• The conversion price is set at issuance and represents the price at which the bond can be converted into common stock.

Advantages

• Convertible bonds offer investors an opportunity for capital appreciation if the underlying stock price increases.
• They provide downside protection in case the stock price declines since they still offer fixed-income payments until maturity.
• Convertible bonds can benefit companies by lowering borrowing costs compared to issuing traditional debt or equity securities.

In summary, convertible bonds offer investors a unique blend of the features of fixed income bonds and equity instruments. They provide potential for capital appreciation while also limiting downside risk. Convertible bonds typically have lower yields than non-convertible bonds because they offer potential upside through equity participation.

Conclusion

Investing in bonds is a great way to diversify your portfolio and manage risk. The different types of bonds in India have their own unique features, varying risks, and different returns. 

Government bonds are generally considered the safest option, while corporate bonds offer higher yields with a slightly higher risk. Municipal bonds can provide tax benefits, while convertible bonds offer the potential for capital appreciation. 

It is important for investors to carefully evaluate their investment goals and risk tolerance before choosing a particular type of bond. Consulting with a financial advisor can also help investors make informed decisions about their bond investments.

Grip offers corporate bonds through its platform, allowing Indian investors to invest in debt securities issued by various companies. These bonds are rated, regulated and secured. To invest in these fixed income bonds sign - up on Grip Invest today.

Frequently Asked Questions On Different Types Of Bonds

1. Is investing in bonds a good idea?

The Indian market at present is very favourable for bond investments. Bonds are generally considered to be less risky than stocks because they offer a fixed income stream and are typically less volatile. Additionally, investing in bonds can provide diversification benefits for an investor's portfolio.

It is important to note that bond investments are not completely risk-free, and investors should carefully evaluate the creditworthiness of the issuer before investing. Overall, investing in bonds can be a good idea for investors seeking stable income streams with lower risk compared to other asset classes such as stocks or real estate.

2. How to buy bonds in India?

The most common methods to buy bonds in India are:

1. Through a broker: Investors can buy bonds through a registered stockbroker. The broker can also help choose the right type of bond based on their investment goals and risk tolerance.
2. Online trading platforms: Several online trading platforms allow investors to buy and sell bonds directly from their accounts. These platforms offer easy accessibility and convenience for investors. 
3. Primary market offerings: Investors can also participate in primary market offerings of bonds issued by companies or government agencies. These offerings are typically announced through public notices, and interested investors can apply for them through designated banks or brokers.
4. Mutual funds: Another option is to invest in bond mutual funds, which pool money from multiple investors to purchase a diversified portfolio of bonds. It is a good option for investors who do not have the expertise or resources to select individual bonds.

3. Which is the best bond to invest in?

There is no one "best" bond to invest in, as the ideal bond for an investor will depend on their specific financial goals and risk tolerance. However, there are a few factors to evaluate bonds:

• Creditworthiness of the issuer: Bonds issued by reputable companies or government agencies with a strong credit rating are generally considered to be less risky.
• Yield: High-risk bonds generate higher income.
• Maturity: Short-term bonds have a lower risk but offer lower returns, while long-term bonds carry more risk but offer potentially higher returns.
• Liquidity: Some bonds can be easily bought and sold in the market. It is important for investors who may need to sell their bonds before maturity.

It is advisable to consult with a financial advisor before investing in bonds to ensure that the investments match up with an individual’s investment goals and risk tolerance.

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