Bonds

Bond (finance)

A bond is a debt security issued by a government, corporation, financial institution, or other entity to raise capital from investors. The issuer borrows money from bondholders and typically agrees to pay interest at specified intervals and repay the principal amount on a predetermined maturity date, subject to the terms of the bond.^[1]

Bonds are an important component of the fixed-income market and are used to finance government expenditure, infrastructure projects, corporate investment, and other activities. Investors may purchase bonds to generate income, diversify portfolios, or manage financial risks.

Characteristics

Bonds have several fundamental characteristics that determine their financial terms and investment risks.

Face value: The principal amount that the issuer promises to repay at maturity, subject to the bond's terms.
Coupon rate: The stated annual interest rate applied to the bond's face value.
Maturity date: The date on which the principal is scheduled to be repaid.
Market price: The price at which the bond can be purchased or sold in the market.
Yield: A measure of the return associated with the bond, calculated according to a specified methodology.
Credit rating: An assessment of the issuer's or bond's creditworthiness provided by a credit rating agency.

Bonds may be issued at face value, at a discount, or at a premium. Their market prices can change after issuance as interest rates, credit conditions, and investor expectations change.

Types of bonds

Government bonds

Government bonds are debt securities issued by national governments to finance public expenditure and manage government borrowing. Their credit risk depends on the issuing government's financial position, currency of denomination, and capacity to meet its obligations.

In India, the central government issues dated securities and Treasury bills, while state governments issue State Development Loans (SDLs). Government securities are traded in the domestic debt market.

Corporate bonds

Corporate bonds are issued by companies to finance business operations, capital expenditure, acquisitions, and debt refinancing. Their credit risk varies according to the issuer's financial condition, cash flows, debt levels, and contractual obligations.

Municipal bonds

Municipal bonds are issued by local governments or other public authorities to finance infrastructure and public services. Their repayment may depend on general revenues, specified taxes, or income generated by particular projects.

Sovereign bonds

Sovereign bonds are debt securities issued by national governments. They may be denominated in the government's domestic currency or in a foreign currency. Foreign-currency borrowing can expose an issuer to additional exchange-rate risk.

Zero-coupon bonds

Zero-coupon bonds do not make periodic coupon payments. Instead, they are generally issued or traded at a discount to their face value and provide a return through the difference between the purchase price and the amount repaid at maturity.

Floating-rate bonds

Floating-rate bonds pay interest based on a reference rate or other benchmark that changes periodically. Their coupon payments therefore vary over the life of the bond.

Convertible bonds

Convertible bonds give bondholders the right to convert their debt holdings into shares of the issuing company under specified conditions. They combine debt characteristics with a potential equity investment.

Secured and unsecured bonds

Secured bonds are backed by specified collateral or assets, subject to the bond's legal terms. Unsecured bonds are not backed by specific pledged collateral and rely on the issuer's general creditworthiness and contractual obligations.

Bond markets

The bond market is the financial market in which debt securities are issued and traded. It consists of primary and secondary markets.

The primary market is where issuers sell newly issued bonds to investors. The secondary market enables existing bondholders to sell their securities to other investors before maturity.

Bond trading may take place through exchanges, electronic trading platforms, dealer networks, or over-the-counter markets. Market structure and trading practices vary across jurisdictions and bond categories.

Bond pricing and yields

A bond's price is influenced by its coupon payments, maturity, credit quality, and prevailing market interest rates.

When market interest rates rise, the prices of existing fixed-rate bonds generally decline because newly issued bonds may offer more attractive yields. When market interest rates fall, existing fixed-rate bonds generally become more valuable, all else being equal.

The current yield is calculated by dividing the annual coupon payment by the bond's current market price. The yield to maturity estimates the annualised return an investor would receive if the bond were held until maturity and its contractual payments were made as expected, taking account of its purchase price and payment schedule.

A bond trading above its face value is described as trading at a premium, while a bond trading below face value is described as trading at a discount.

Advantages

Bonds may offer several advantages to investors:

Income generation: Many bonds provide scheduled interest payments.
Portfolio diversification: Bonds can provide exposure to different return and risk characteristics from equities.
Capital repayment: Bonds generally specify a principal repayment amount and maturity date, although repayment remains subject to the issuer's ability to meet its obligations.
Range of maturities: Investors can select securities with different repayment horizons.
Risk management: Certain high-quality bonds may help investors manage portfolio volatility and match future liabilities.

Risks

Bond investments are subject to several risks.

Credit risk: The issuer may fail to pay interest or repay principal when due.
Interest-rate risk: Changes in market interest rates can cause bond prices to fluctuate.
Inflation risk: Inflation can reduce the purchasing power of fixed interest and principal payments.
Liquidity risk: Some bonds may be difficult to sell quickly at a reasonable price.
Reinvestment risk: Interest payments or repaid principal may need to be reinvested at lower rates.
Currency risk: Bonds denominated in foreign currencies may lose value when converted into an investor's domestic currency.
Call risk: Some bonds may be redeemed by the issuer before maturity under specified conditions.

Bonds are not necessarily risk-free. Even securities issued by governments may be exposed to inflation, interest-rate, currency, or other risks.

Bonds and stocks

Bonds and stocks represent different forms of financing and investment.

Feature	Bonds	Stocks
Nature	Debt	Equity ownership
Investor's position	Creditor of the issuer	Shareholder of the company
Payments	Contractual interest, where applicable	Dividends, if declared
Maturity	Usually specified for conventional bonds	Ordinary shares generally have no maturity date
Claims during liquidation	Bondholders generally rank ahead of shareholders, subject to legal priority and the bond's terms	Shareholders receive residual assets after prior claims are satisfied
Potential returns	Interest and changes in market price	Dividends and changes in share price

Bonds in India

India's bond market includes central government securities, Treasury bills, State Development Loans, corporate bonds, municipal debt securities, and other debt instruments.

The Reserve Bank of India manages the issuance and administration of central government securities and Treasury bills and plays a major role in the government securities market. The Securities and Exchange Board of India regulates securities markets and relevant intermediaries, including aspects of the corporate bond market, under the applicable legal framework.

Investors can access eligible bonds through primary issuances, secondary-market transactions, and certain investment funds that hold debt securities. The risks, taxation, liquidity, and regulatory treatment depend on the instrument and the investor's circumstances.