Bonds Overview
This page provides all the details you need to know about the investment in Bonds and it's terminologies.
Table of Contents
What is Bonds?
A Bond is an investment instrument. Generally, a bond is a fixed income instrument in which you (the investor) will get a fixed amount of interest (coupon).
Bonds work like a loan. Generally, loan means you will borrow money from a Bank. You have to pay back the loan amount along with the interest in the form of EMIs (monthly installments) to the Bank within the loan term.
But, in Bonds, the loan system is a bit opposite where in you (investor) are giving money to the Bond issuer. So, the Bond issuer will be responsible for paying you back the amount along with the interest within the bond term.
Generally, Bonds are issued by the Government and other Organisations to raise funds for a development project.
For example, Government of India can issue a bond to raise funds for building a national highway, dam or any other infrastructure project for the development of the country.
How does the Bonds work?
Deposit a lump sum amount and purchase a bond
The bond issuer will pay you the interest (coupon) amount at regular intervals (every 6 months or every year) during the term of the bond
At the end of the term, you'll get your deposit amount back
Features
Bonds come under the debt investment category
Quite a few bonds are backed by the Government of India and hence they are safe investment
Generally, bonds are low risk category of investment
You'll get fixed amount of interest (coupon) at regular intervals (every 6 months or every year)
Few bonds provide income tax benefits
If you want to discontinue the bond, then you can try to sell it on the Secondary market (Share Market)
54EC Bonds (Capital Gain Bonds) will help you to save Long Term Capital Gains Tax (CGT) from a sale of a real estate property
Nomination facility is available on all the bonds
Income Tax Benefits
The income tax benefits will vary from one bond to another. Before investing, you need to check the following things to get a better understanding of tax benefits.
Deposit Amount:
You need to check if the deposit amount will get tax deduction benefits under Section 80C of the Income Tax Act.
In general, for most of the bonds, there is no deduction benefits under Section 80C.
Interest (Coupon) Amount:
You need to check if the interest (coupon) amount paid by the Bond Issuer is taxable or not.
In general, for most of the bonds, the interest payout amount is taxable. But, in "Tax Free Bonds", there is no tax for the interest amount.
TDS (Tax Deducted at Source):
You need to check if TDS is deducted by the Bond Issuer while paying the interest amount.
Maturity Amount:
You need to check if the maturity amount paid to you at the end of the term is taxable or not.
In general, for most of the bonds, the maturity amount is tax free as the bond issuer will pay you back your deposit amount.
Capital Gains Tax (CGT):
If you try to sell the bond before the early redemption period (lock-in period) or maturity period, then you need to pay the capital gains tax.
If you sell the bond before 1 year from the date of purchase, then you need to pay short term capital gains tax (STCG).
If you sell the bond after 1 year from the date of purchase, then you need to pay long term capital gains tax (LTCG).
Please check Capital Gains Tax page for more details about tax percentage.
Bond Terminologies
The bond market follows it's own terminologies. It is important for you to understand these terms before investing.
Face value (or Par value):
It is the amount the Bond issuer promises to repay you on the maturity date of the bond.
For example, if the face value of the bond is Rs. 1,000, then this is the amount you'll get on the day of maturity.
Market value:
It is the current market price of the bond. This comes into picture when you try to buy or sell a bond on the secondary market (Share Market).
Before maturity date, the market value of the bond will be more than or less than the face (par) value of the bond.
Premium & Discount:
Premium means an increase in the market value of a bond.
Discount means a decrease in the market value of a bond.
Example:
Let's assume the face value of a bond is Rs. 1,000.
After some time, if the market value of the bond is Rs. 1,020, then it is a premium of Rs. 20.
After some time, if the market value of the bond is Rs. 980, then it is a discount of Rs. 20.
Coupon:
Coupon is nothing but the interest amount paid to you by the Bond issuer.
The coupon amount will be paid to you regularly (every 6 months or 12 months) from the date of issue till maturity.
Coupon Rate (%):
It is the annual interest rate (%) at which the coupon (interest) amount will be paid to you by the Bond issuer.
The coupon rate is calculated on the face value of the bond, not on the market value.
Cumulative:
Cumulative means compounding.
The interest earned in the bond will be compounded and it'll be paid to you at the time of maturity.
Non-cumulative:
Non-cumulative means there is no compounding.
The interest earned in the bond will not compound. It'll be paid to you at regular intervals (every 6 months or 12 months). It is also known as interest payout method.
Maturity:
It is the maturity amount and it'll be paid to you on the day of maturity.
In general, for most of the bonds, your deposit amount will be paid back to you on the day of maturity.
Yield (%):
The yield is the return (%) that you get from the Bond. The yield will be the same as that of the coupon rate (interest rate) at the face value of the bond.
But, when the market value of the bond increases or decreases, then the yield will be different to the coupon rate.
If the Bond price increases, then the yield will be less than the coupon rate.
If the Bond price decreases, then the yield will be more than the coupon rate.
Example:
Let's assume the face value of the Bond is Rs. 1,000 and the coupon rate is 5%. So, the coupon (interest) amount you receive from the bond will be Rs. 50.
At face value of Rs. 1,000, the yield (%) will be same as that of coupon rate. That is, 5%.
After some time, if the bond price increases to Rs. 1,020, then the yield will be 4.90% (that is, 50 divided by 1020).
After some time, if the bond price decreases to Rs. 980, then the yield will be 5.10% (that is, 50 divided by 980).
Yield to Maturity (YTM):
The yield to maturity is the total return (%) expected from the bond if you hold it till the maturity date.
It is used as a factor to decide whether purchasing the bond is a good investment or not.
Secured & Unsecured:
Secured bond is a safe investment as it is secured by the Bond issuer.
For example, the Government of India bonds are secured bonds as they are backed by the Government. Secured bond is low risk and safe investment and hence they offer slightly low returns. They are suitable for low risk investors.
Unsecured bonds are not secured as they are not backed by the bond issuer. You'll go with the faith and credit rating of the bond issuer if you want to invest in unsecured bonds. For example, the Corporate Bonds are unsecured bonds.
Unsecured bonds offer high returns and hence they are risky investment option. They are suitable for high risk investors only.
Credit Rating:
Credit rating of a bond represents the credit quality of the Bond issuer. These ratings are published by the credit rating agencies.
These ratings will help the investors to decide whether the Bond issuer has the financial capability to pay the face value and the coupon payments in a timely manner.
Listed & Unlisted:
Listed bonds are those that are listed on the Stock Exchanges (Share Market). You can buy and sell these bonds on the Stock Exchange.
Unlisted bonds are not listed on the Stock Exchanges and hence you can't buy or sell them on the Exchange.
Zero Coupon:
Zero coupon bonds means there will be no coupon (interest) payout during the term of the bond. Generally these bonds are sold at a discounted rate as compared to the face value of the bond.
Example:
The face value of the bond is Rs. 1,000. Zero coupon bonds may be sold at say Rs. 800.
At the end of the Bond term, you'll get Rs. 1,000. It is like you'll invest Rs. 800 and you'll get Rs. 1,000 on the day of maturity. You won't get any coupon (interest) during the bond term.
Taxable & Tax Free:
Taxable means the coupon (interest) amount from the Bond is taxable. You need to declare the coupon amount under "Income from Other Sources" and you need to pay income tax as per your tax slabs.
Tax Free means that the coupon (interest) amount is tax free. You need not pay any income tax on the coupon amount. The entire coupon amount is yours.
Callable (or Redeemable):
Callable means that the bond can be called back by the Bond issuer before the maturity date.
This generally happens when the interest rate decreases in the market. The bond issuer can call back the bond and then re-issue another bond at a lesser interest rate.
Callable bonds work in favour of the bond issuer, not in favour of the investor.
Puttable:
Puttable means that the bond can be put or sold by the investor (you) before the maturity date.
This generally happens when the interest rate increases in the market. The investor (you) can sell the bond back to the Bond issuer and get the face value back.
Puttable bonds work in favour of the investor (you), not in favour of the bond issuer.
Convertible & Non-convertible:
Convertible bonds are corporate bonds that can be converted into a predetermined number of shares of the issuing company.
Non-convertible means the bond can't be converted into shares.
Transferable & Non-transferable:
Transferable means the bond can be transferred from one person to another person.
Non-transferable means the bond can't be transferred to another person.
Negotiable & Non-negotiable:
Negotiable means the bond can be easily transferred to another person. For example, the bearer bond.
Non-negotiable means the bond can't be easily transferred to another person.
Types of Bonds
There are quite a few types of Bonds depending upon the issuer. The types are given below.
Government bonds
Municipal bonds
Public sector bonds
Corporate bonds
The details are given below.
Government Bonds:
These bonds are issued by the Government of India. Hence, they are safe and risk free investment. They provide guaranteed returns and they are suitable for low-risk investors.
Municipal Bonds:
These bonds are issued by the State Government or the local Government agencies. These bonds are also safe investment options as they are backed by the State or local Government.
Public Sector Bonds:
These bonds are issued by the Government affiliated organisations. These bonds are also safe investment options as they are guaranteed by the Government.
Corporate Bonds:
These bonds are issued by big companies. They offer higher returns but the risk will also be high. This is suitable for high-risk investors.
Where can You Purchase the Bonds?
In general, you can purchase the bonds from the following two places.
Primary market
Secondary market
The details are given below.
Primary Market:
Primary market is the place where you can purchase the bond when it is first issued during the subscription period.
Example:
Let's assume that the Government announces that it is going to issue a new bond during the second week of April and that you can purchase it from a list of specified Banks.
In this example, the primary market refers to the Banks.
Secondary Market:
Secondary market is nothing but the Share Market where you can purchase the past issues of the bond.
For any reason, if you are unable to buy a bond on the primary market during the initial subscription period, then you can try to purchase them on the secondary market.
This is also the place where you can sell the bond before it's maturity date.
NSE (National Stock Exchange) and BSE (Bombay Stock Exchange) are examples of secondary market.
How do You Purchase the Bonds?
You can purchase the bonds either directly by yourself or through an agent.
You can purchase the bonds using one of the following methods.
Cash (up to a certain limit)
Cheque
Demand Draft
Online (electronic)
When you purchase a bond, you can keep it in one of the following modes.
Physical form (bond paper)
Demat form (online)
When you purchase a bond, you will receive a Certificate of Holding from RBI or agency Banks.
For the Demat form, you need to have a Bond Ledger Account (BLA).
Bond Ledger Account (BLA):
Bond Ledger Account (BLA) is an account with RBI or any Agency Bank in which you can hold the bonds and other Government securities in Demat form.
Pre-mature Closure
Pre-mature closure rules will be different for every bond.
Few bonds may provide pre-mature closure options. Few bonds may not provide this option at all. So, you need to check the rules before investing.
In general, for most of the bonds, if you close pre-maturely before the maturity date, then you may need to pay Capital Gains Tax (CGT).
Death of the Bond Holder
Unfortunately, if you die during the tenure of the bond, then the bond will be transferred to your nominees or legal heirs.
After that, your nominees should hold the bond till early redemption period or till maturity date.
Your nominees will receive the coupon payments (if any) at periodic intervals and the face value on the maturity date.
Loan Facility
In general, the bonds can be used as a collateral security to get loan from the Banks, Financial Institutions and Non-Banking Financial Companies (NBFC).
But, the rules will be different for every bond. So, you need to check the rules before investing.
Nomination Facility
Nomination facility is available on all the bonds.
You can nominate one or more people as your nominees. Also, you can change nominations at any time during the tenure of the bond.