Definition of Bond
A bond is a debt product sold by governments, municipalities, or corporations to raise capital. An issuer promises investors the return of periodic interest payments, known as coupon payments, and returning capital at maturity repaid known as face value.
Bonds form an integral part of the financial system but are also an investment tool whereby investors utilize them in creating stable returns while also diversifying their other investment portfolios. India’s bond market has been a journey through time and consists of many bonds for investors-that is, retail as well as institutional. This is a general overview of bonds and kinds of bond markets of India.
What Are Bonds?
A bond simply refers to a loan given by the investor to the issuer, who could be a government or a company. When you acquire a bond, you essentially lend money to its issuer for some period of time. The issuer agrees to pay you an amount of interest periodically-called coupon-and repay your principal at maturity.
A few key words associated with bonds
Par Value or Face Value: amount the issuer pays at maturity.
Coupon Rate: rate at which the issuer pays the bondholder in interest form.
Maturity Period: number of years till maturity, when time the principal is repaid by the issuer to the bondholder.
Yield: The amount of return that the investor earns on the bond, as computed by the coupon rate, price, and time to maturity.
Types of Bonds in India
The Indian bond market is diversified since there are all types of bonds-complying with the diversified needs of all investors. The two major categories of bonds available in India are as follows:
1. Government Bonds (G-Secs):
G-secs, also known as government bonds, are also sold by the Reserve Bank of India to the central government. G-sec is totally risk-free because it carries the credit of the government.
Types of Government Bonds
Treasury Bills:Debt securities with maturity periods up to one year.
Government Savings Bonds: Long-term bonds which offer low interest, sold at the retail level.
Sovereign Gold Bonds: These are basically gold price-linked bonds issued by the government for the purpose of diversifying investment choices.
State Government Bonds: The state government issues bonds for financing particular projects at the state level.
2. Corporate Bonds
Corporate bonds are issued by companies to expand, for the purpose of acquiring long-term or short-term working capital, or to refinance debts.
More risks are involved with a corporate bond than a government bond since corporate bonds rely on the financial soundness of the company issuing them, however they do offer a much higher return to offset that risk.
Classes of Corporate Bonds
Debentures: Issued by companies as unsecured loans, these are arguably the most popular of corporate debt instruments. Their repayment depends on the credit rating of the issuer.
Bonds: An intermediate type of debt security which is also secured, in that they are specific secured on certain assets or collateral.
Convertible Bonds: Those that may, at a future date, and at the discretion of bondholder, be issued as equity of the issuer company.
Non-Convertible Bonds (NCBs): These cannot be turned to share capital of the issuing company and usually have a superior coupon.
3. Municipal Bonds
Generally known as munis primary bonds are instruments created by the local government entities such as municipal corporations, urban development authorities and other similar government undertakings.
These are issued for the purposes of constructing infrastructures such as roads, bridges or schools. In some instances, these bonds even have tax-free interest income and are therefore tax efficient for the bond holders.
4. Infrastructure Bonds
The infrastructure bonds are raised only for the purpose of financing the development of infrastructural facilities such as investment in constructing highways, energy projects, airports etc. Most of the time, these are provided by public sector companies or those firms which are engaged in developing infrastructure projects.
It is because of the tax benefits associated with such bonds that makes them appealing to potential patrons who wish to contribute to the growth of the economy.
5. Foreign Currency Bonds
Foreign currency bonds are also termed as rupee or dollar denominated bonds as they may be issued by Indian firms or Government but the currency in which the bond is created is that which is not Indian namely us dollar or euros. They serve dual purpose of helping international investors invest in Indian companies and assets while Indian companies borrow from overseas markets.
6. Tax-Free Bonds
Lately, some such bonds have been issued by government sponsored institutions like NHAI, PFC and REC providing benefit of interest earning for the investors.
Indian Bond Market
Indian Bond Market can be classified into two broad categories: primary market and secondary market.
1. Primary Market
The primary source of issuing bonds is the primary market. In case of government, issues these bonds to the investors through public offerings and direct sales. After its issue, bonds get traded in secondary market.
The process of issuing bonds is included with a very detailed pricing, credit rating process, and regulatory approvals.
The investors buy the bonds in the primary market so that they can enjoy the interest rate guarantee as well as security and predictability offered by the government and corporate bonds.
2. Secondary Market
Secondary market Trades in bonds that have already been issued. Unlike equities, the Indian bond market is still relatively emerging.
However, the RBI has taken bold steps towards the development of the bond market’s liquidity. For this purpose, it has made arrangements for direct selling and buying of bonds through various stock exchanges, NSE and BSE or over-the counter among banks and other financial institutions.
3. OTC Market
In an over-the-counter market, buyers and sellers trade directly with one another, rather than through an exchange formal. They often use banks or brokers. Such markets often reach institutional investors, but retail investors may be accessible through brokers.
4. Exchange-Traded Bonds
Exchange-Traded Bonds are bonds traded in the stock exchange and thus can be sold and bought like shares. ETBs combine the predictability and safety of bond investments with the liquidity of a secondary market.
Challenges in Indian Bond Market
Even at a growth level, many challenges face India’s bond market.It can also be said that the bond market of India is highly institutional and has low participation from the retail sector, mainly because of low awareness regarding the market and the products are highly complex.
Liquidity Issues
In comparison, the secondary market for bonds is not as liquid as equities. For that reason, it becomes highly challenging for most investors to buy or sell bonds.
Interest Rate Sensitivity
The interest rate sensitivity is the price a bond. Interest rate movements of any kind can send the value of outstanding bonds down; thus, as investors experience losses in capital.
Conclusion
From government securities to corporate bonds and infrastructure bonds, the Indian bond market has something to give each kind of investor.
Having a view to providing bond returns in addition to offering diversification, bonds can be a part of the investor’s portfolio in emerging fields, such as those of financial markets and heightened awareness.
However, the attendant risks like fluctuations in interest rates, credit risk, and liquidity concerns need to be understood by potential investors.
In fact, the diversified range of Indian bond offerings serves well to create a balanced portfolio that can correspond with the investment goals and risk acceptance of the investors.