When it comes to investing our hard-earned money Fixed Deposits and Post Office schemes are the most popular forms of investment among Indian investors. However, with dipping interest rates these options are losing their shine. At such a time, bonds turn out to be a safe bet for such risk-averse investors who are looking beyond traditional FDs. Here are the things you should know before investing in bonds.
What is a bond?
Bonds are issued by governments and corporations when they want to raise money. By buying a bond, you’re giving the issuer a loan, and they agree to pay you back the face value of the loan on a specific date, and to pay you periodic interest payments along the way.
- Unlike stocks, bonds don’t give you ownership rights. They represent a loan from the buyer (you) to the issuer of the bond.
- Bonds can be issued by companies or governments and generally pay a stated interest rate.
- The market value of a bond changes over time as it becomes more or less attractive to potential buyers.
- Bonds that are higher-quality (more likely to be paid on time) generally offer lower interest rates.
- Bonds that have shorter maturities (length until full repayment) tend to offer lower interest rates.
The difference between stocks and bonds can be summed up in one phrase:
Debt versus Equity
Bonds represent debt, and stocks represent equity ownership. Investing in debt is relatively safer than investing in equity because debtholders have priority over shareholders.
If a company goes bankrupt, debtholders (creditors) are ahead of shareholders in the line to be paid. In this worst-case scenario, the creditors might get at least some of their money back, while shareholders might lose their entire investment depending on the value of the assets liquidated by the bankrupt company.
Here are the terms you should know while investing in bonds.
- Coupon: Interest rate paid by the bond. In most cases, it won’t change after the bond is issued.
- Yield: This is a measure of interest that takes into account the bond’s fluctuating changes in value. There are different ways to measure yield, but the simplest is the coupon of the bond divided by the current price.
- Face value: This is the amount the bond is worth when it’s issued, also known as “par” value.
- Price: This is the amount the bond would currently cost on the secondary market. Several factors play into a bond’s current price, but one of the biggest is how favorable its coupon is compared with other similar bonds
Types of Bonds
- Government Bonds(G-Securities): A government bond is a debt instrument issued by the Central and State Governments of India and hence these are virtually risk-free investments.
- Corporate Bonds: Corporate bonds are debt securities which can be issued either by private and public corporations. In some cases, the bonds are listed on the stock exchanges. These are high risk investments.
- PSU Bonds: PSU bonds are issued by government owned PSUs. There are a variety of options available under this category such as Taxable, Tax-Free etc. These bonds come with low risk.
Who should invest?
Risk-averse investors, retired individuals should ideally look at these kinds of instruments. There is no specific time to invest in these bonds unless one is willing to bet on the interest cycle which is meant for seasoned professionals.
Investors should ideally look at investing in high-rated bonds for safety. However, those who are willing to take a slight risk of default can go for a lower-rated debt which gives a higher return.
Want to learn more about investing in Bonds?
Bonus: We have made a detailed video on Types of BONDS & How to invest in them? Click here to watch the video.