What are Bonds and Types of Bonds

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A brief guide on the meaning and different types of bonds

Key Takeaways

• Bonds are fixed-income debt securities where investors loan money to an entity to raise capital.
• The coupon rate or interest rate for bonds can be fixed or floating.
• Indexed bonds are linked to inflation-beating indices.
• Investors can buy electronic gold through Sovereign Gold Bonds.
• Most bonds come with longer investment horizons, lasting 5 or more years.

Stock market investments assist with capital appreciation and corpus creation. However, investing in the stock market entails bearing risks and losses. As an investor, you must attempt to mitigate your risks by diversifying your investment portfolios. You can use low-risk Bonds as a buffer to such volatile stock investments. Read on to know more about what are bonds and types of bonds.

What Are Bonds?

Public and private companies always need capital to expand their business. Typically, the required capital exceeds the loan amount a bank can lend. These companies then issue Bonds to public investors and raise money for the company. So, when you buy Bonds from a company, you lend money to them. Like any other loan, the borrower (i.e., the public or private company) pays interest on the loan amount. The bond-issuer also informs you about the interest rates or returns you can expect from your investment upon maturity. Therefore, by definition, bonds are fixed-income debt securities.

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Bond Terminology

Besides knowing what is the meaning of bonds, you should familiarise yourself with some bond-specific terms. The commonly used ones are as under:

• Issuer: Company selling the bonds
• Coupon Rate: Rate of Interest for holding the bonds.
• Face Value: The price of the Bond on its maturity day.
• Maturity Date: The day when the issuer pays back the amount.
• Debt holder/creditor: Investors who own the bonds.

Types of Bonds

The different types of bonds to invest in India include:

Fixed Coupon Rate Bonds

These bonds come with a fixed interest or coupon rate since the day the company issues the bonds. Corporate Bonds and Government Bonds are usually of the fixed coupon rate type where the company pays interest yearly, half-yearly, quarterly or monthly until maturity or redemption.

Floating Coupon Rate Bonds (FRB)

Here, the coupon rates are not fixed and fluctuate until maturity. The variable coupon rate is re-set at pre-announced half-yearly or yearly intervals.

Capital Indexed Bonds

The principal amount is invested in an index to protect the principal amount of the investors from inflation.

Inflation-Indexed Bonds (IIB)

In IIBs, both the principal amount and coupon rate are protected against inflation.

Zero-Coupon Bonds

Zero-Coupon Bonds pay zero interest. Instead, these bonds get issued at a discounted price, and you can redeem them at face value at maturity. The return is the difference between the discounted price and the Bond's face value.

Sovereign Gold Bonds (SGB)

SGB investments entail buying gold in electronic or digital form. The interest rate is fixed at 2.5% per annum with 8-year tenure. You can redeem the Bond prematurely after the 5th year.

7.75% Savings Taxable Bonds

Issued in 2018, these bonds are high-yield and pay interest of 7.75% per annum. Coupons on such bonds are taxable, per Income Tax Act, 1961.

Final Note

Bonds are a safe addition to your investment portfolio. These investment instruments are regulated by the government and offer lower but guaranteed returns. With different types of bonds to choose from, you can select those that complement your investment goals.

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*Disclaimer: This article is for information purposes only. We recommend you get in touch with your income tax advisor or CA for expert advice.