What are bonds?
Bonds are fixed income instruments which pay fixed rate of interest at regular intervals and the principal amount on maturity. Bonds as an asset class are very popular in the developed economies. However, the bond market in India has historically been relatively small. In more recent times, with Bank FD interest rates declining, bonds are gaining a lot of popularity among retail and HNI investors.
How do bonds work?
You can buy bonds both from the primary market (at the time when the bond is issued) or from the secondary market (stock exchanges). You need to have Demat accounts to invest in bonds in secondary market. If you buy in the primary issue, you will get the bond at face value. In the secondary market, the bonds will be priced either at premium or discount to the face value based on prevailing interest rates. The bond will make periodic interest payments to you based on the coupon rate. On maturity you will get the face value of the bond. You can also sell the bond before maturity in the secondary market at prevailing market price.
Key terms to understand in bond investing
Secured / unsecured :
Under this service, the choice as well as the timings of the investment decisions is solely lies with the Portfolio Manager.
Face Value :
The bonds are issued at face value. Face value is the amount that will be paid to you upon maturity of the bond. Coupon or interest paid by the bond is on face value. Bonds may trade at premium or discount to the face value. In other words, if you are buying the bond in secondary market (i.e. stock exchanges), then the price at which you buy will be higher or lower than the face value.
Coupon Rate :
This is the rate of interest that will be paid to you on a periodic basis. For example, if face value of a bond is Rs 1,000 and the coupon rate is 8%, then you will get Rs 80 as interest every year
Frequency of coupon payments :
This refers to the intervals at which coupon payments will be made e.g. half yearly, annual etc.
Redemption date :
This refers to the date when the bond will mature. You will get the face value of the bond, along with accrued interest (if any) on the redemption date.
Accrued Interest :
Accrued interest is the interest accrued by the seller from the last coupon payment date till the date on which the bond is sold. Since the buyer will get the full years interest on the next coupon date, the accrued interest is included in the bonds quoted price. The bonds price including the accrued interest is known as the dirty price. The clean price of the bond = Dirty price - accrued interest.
Yield to maturity :
YTM of a fixed income instrument is the return on investment (assuming interest payments are re-invested at the same rate) if you hold the instrument till its maturity. When calculating yields, both interest payments (coupons) and principal payment (face value) on maturity must be taken into consideration. Higher the YTM, higher the returns. YTM.
Duration :
Duration refers to the interest rate risk of a bond. There are two types of durations - Macaulay Duration and Modified Duration. Macaulay and Modified Durations are closely related. Macaulay duration is the weighted average term to maturity of the cash flows from a fixed income security. In simplistic terms, Macaulay Duration is the weighted average number of years an investor must maintain a position in a fixed income instrument until the present value of the fixed income instruments cash flows equals the amount paid for the instrument. Duration and maturity are related - longer the maturity, longer is the duration. It is important for you to know that duration is directly related to the interest rate sensitivity of a bond. Higher the duration, higher is the bonds sensitivity to interest changes. Modified duration is simply the percentage change in price due to the percentage change in interest rate.
Bond rating :
Bonds are rated by credit rating agencies like CRISIL and ICRA. Higher the credit rating lower is the credit risk. You should know that bonds with lower ratings will have higher YTMs but the risk is also higher. You should make informed investment decisions.
Different types of bonds
Corporate Bonds - These are secured bonds issued by companies.
Sovereign Gold Bonds (SGBs) - These are gold bonds (backed by gold) issued by RBI on behalf of the Government.
Government Securities (G-Secs) - These are Government bonds issued by RBI on behalf of the Government of India. These bonds have sovereign guarantee.
Non convertible debentures (NCDs) - These are unsecured bonds issued by companies.
Capital Gains Bonds - You can save capital gains tax arising out sale of capital assets e.g. property etc by investing in capital gains bonds u/s 54EC.
How to invest in bonds?
You can invest in bonds through us, You need to have a demat and trading account in order to invest in bonds. You may contact us for further details.
Gold Bonds
Gold bonds are financial instruments issued by governments or financial institutions linked to the price of gold. Investors who purchase gold bonds effectively own a specific quantity of gold, and the bonds' value fluctuates with changes in the gold price. These bonds offer an alternative way to invest in gold without physically owning and storing the precious metal.
How can we help?
We can assist investors in understanding the mechanics and potential risks of investing in gold bonds. Based on our analysis and insights into gold market trends, investors can take informed decisions on using such instruments in their portfolios.
NCDs (Non-Convertible Debentures)
Non Convertible Debentures are long term investment opportunities issued by companies to raise funds. The NCDs have no collateral and hence heavily dependent on the creditworthiness of the company. The credit scores of the company issuing the NCD should be considered before investing in such instruments. Even the NCDs are rated by the rating agencies. NCDs carry a fixed rate of interest and a fixed maturity period. The money is raised through a public issue. Subsequently, they are traded over the counter or on the exchange. Investors in NCDs should do a thorough check on the company that is issuing the debentures with a view to the reason that the funds are being raised. NCDs issued by high rated companies are generally safe and offer certain other benefits like tax exemptions at source and high liquidity as they are tradable on the stock exchange before they reach maturity.
How can we help?
We can help at two levels, first we can assist investors in assessing the credit rating and financial health of the companies issuing NCDs. We will analyse the terms and conditions of the NCD offer, evaluate the risk associated with the interest rate and creditworthiness of the issuer, and guide to suitable NCDs that align with the investor's income requirements and risk tolerance. The second place where we can assist is to execute the transaction.
Fixed deposits has traditionally been and still is the most popular investment option in India. As per RBI's report on household savings, 56% of household financial assets are invested in Bank FDs. Corporate Fixed Deposits are term deposits like bank FDs. They offer fixed rate of interest and principal amount on maturity. However, instead of banks, corporate FDs are offered by non banking financial companies (NBFCs). Corporate FDs are very popular among informed investors since offer higher returns compared to bank FDs.
Bank FD versus Corporate FD
Rate of return:
Interest rates of corporate FDs are usually higher than interest rates of banks FDs. For example current 3 - 5 year FD interest in SBI is 6.1%, whereas Bajaj Finance is offering 7% interest rate on 3 - 4 year FD. Interest rates of corporate FDs vary from one company to another depending on the credit rating of the company. We will discuss about credit ratings later.
Tenure:
The tenure for bank FDs range from 7 days to 10 years. The tenure for corporate FDs range from 12 months to maximum 4 - 6 years. If you want to invest for very long tenure e.g. 8 to 10 years, then bank FD will be the only term deposit option for you. However, for shorter tenures you may consider corporate FDs.
Lock-in period:
There is no lock-in period in bank FDs. Corporate FDs may have lock-in period. Usually lock-in period for corporate FDs is 3 months; you cannot make any withdrawal prior to the completion of the lock-in period. However, not all corporate FDs may have lock-in periods.
Premature withdrawals:
Premature withdrawals are allowed in both bank and corporate FDs. However, penalties may apply for premature withdrawals may be applicable for both bank and corporate FDs. If you want the flexibility of making premature withdrawals, then bank FDs will be the more favourable option for two reasons (a) no lock-in period (higher liquidity) and (b) lesser premature withdrawal penalty. While bank FDs may offer more flexibility for premature withdrawals, you should weigh this as a trade-off against higher returns offered by corporate FDs.
Taxation:
Taxation of bank FDs and corporate FDs is the same. The interest paid by the FD is added to your income and taxed as per your income tax slab.
Points to consider for investing in corporate FDs
Interest rate:
Different NBFCs offer different interest rates on their FDs. You should compare different FDs and make informed investment decisions. However, you should also take credit risk into consideration.
Credit risk:
Credit risk refers to the NBFC's failure of meeting interest and / or principal payment obligations, exposing the investor to potential loss of income and / or capital. You should consider the credit rating of the instrument and make informed investment decisions.
Tenures:
Corporate FDs may offer different interest rates for different tenures; interest rates are usually higher for longer tenures. You should decide as per investment needs.
Mode of interest pay-out:
Corporate FDs offer both periodic (non cumulative) and cumulative interest pay-out. In periodic interest payout, the interest will be paid to monthly, quarterly, half yearly or yearly; the rate of interest will differ for different pay-out intervals. In cumulative interest pay-out the interest is re-invested and you get the benefits of compound interest. You should decide on cumulative or non cumulative interest depending on your investment needs.