Bond

Bond

Subject: Economy

Section: Financial markets

Concept:

• Bond is a fixed-income instrument that represents a loan from an investor to a borrower.
• It is a contract between the investor and the borrower, where the borrower uses the money to fund its operation and the investors receive interest on the investment. Bonds are high-security debt instruments that fall under the fixed income asset class.
• It enables an entity to raise funds to fulfill the capital requirement for funding various projects.
• These are issued by the government, corporates, municipalities, states, and other entities to fund their projects may be backed or not backed by assets.
• These bonds have a maturity date (tenure) and when once that is attained, the issuer needs to pay back the amount along with a part of the profit to the investor.

Bonds have three components that are used to calculate a bond yield:

1. The principal
2. The coupon rates
3. The maturity dates

When the borrower issues bonds, an agreement is made between the borrower and the lender where the issuer of the bond promises to pay back the principal amount on the maturity date. The issuer also pays the interest on the money borrowed (Coupon) throughout the tenure.

Features of a Bond

• Issue Date: The issue date of bonds is the date from which the interest starts accruing.
• Coupon Rate: The interest rate at which a bond is issued, which the company is liable to pay to the investors is referred as the coupon rate. Coupon payments are made semi-annually or annually.
• Maturity Date: It is the date on which the issuer pays back the Bonds’ face value to the investor. Before investing, check the maturity period of the Bond and invest as per your financial goal.
• Taxation: Certain Bonds provide tax benefits, while there are few corporate bonds that levy tax on their Bonds. Also, certain Bonds issued by the government, municipality Bonds, and a few more don’t impose a tax on the profit earned.

Advantages of Bonds

• Portfolio Diversification: Diversification can provide you with better risk-adjusted returns. Also, diversification with bonds can help preserve capital for equity investors during times when the stock market is slump.
• Lower Risk: Bonds are long-term investment instruments with low-risk associated.
• Fixed Return on investment: Bonds pay interest at regular intervals and also, when Bonds mature, the investor receives the principal amount. In Bonds, the investor knows the exact return he/she will be getting.

Different types of Bonds

These can be divided by the rate, type of interest, or coupon payment. 

• Callable Bonds: When a Bond issuer calls out his right to redeem the Bond even before it reaches its maturity, it is referred to as a Callable Bond. This option is exercised by the Bond issuer. An issuer can convert a high debt bond into a low debt bond.
• Fixed-rate Bonds: Bonds whose coupon rate remains the same through the course or tenure of the investment, it is referred to as Fixed-rate Bonds.
• Floating-rate Bonds: Bonds whose coupon rate vary during the tenure of the investment, then it is referred to as Floating-rate Bonds.
• Zero Coupon Bonds: Zero coupon bonds When the coupon rate is Zero and the Bonds issuer pays only the principal amount to the investor on maturity. It is called Zero-coupon Bonds.
• Puttable Bonds: These are those Bonds where an investor sells their bond and get their money back before the maturity date, then it is called as Puttable Bonds.

What is YMT (Yield To Maturity)? It  is one of the ways through which one can price Bonds. It is the total of expected return for an investor if the bond is held till maturity. It is a long-term yield but represented as an annual rate