What are bonds?
A Bond (or Fixed Income Securities) enables investors to loan money to an entity1in this case – governments, companies and other type of issuers, both public and private . Investors do so for a fixed period of time, in return for a fixed interest paid periodically 2annually, semi-annually, quarterly, etc . The investor does not get any ownership interest in the organisation on buying its bonds, unlike how they do when they invest in equity stock.
Bonds are issued by entities to raise money for financing a variety of projects and activities.
Who determines the maturity period and the rate of interest of a bond?
The issuer. Payment of interest, and repayment of the principal amount, are contractual obligations of the issuer to the investor
Why should I consider investing in Bonds?
The following are some of the reasons for investing in bonds –
- Government securities are generally considered risk free, because they represent the acknowledgement of a debt obligation by the central or state government. Corporate bonds are normally considered less risky as opposed to investing in equities.
- Holding of cash in excess of the day-to-day needs does not give any return, and investment in gold has its own problems. Bonds are a good pick for those who wish to protect their capital, and earn a fixed, higher than FD return on their investment.
- Bond prices are readily available due to a liquid and active secondary market and a transparent price dissemination mechanism.
Also, here are some risks associated with investing in bonds –
Default Risk (or Credit Risk) The risk that – the issuer of a bond may be unable to make timely payment of interest or principal.
Interest Rate RiskThe risk of an adverse change in the interest rate prevalent in the market. Eg. bond ABC is issued at a coupon rate of 8% and face value of 100. Now there is an increase in the market prevailing interest rate, suddenly ABC at 8% is not an attractive investment option, and the new bonds of a similar rating are being issued at (say) 8.5%. Now if the owners of ABC want to sell, they won’t be able to sell at 100, but at a price less than 100, i.e. the price at which the return on ABC is equal to the return on an equivalent market prevailing investment option.
Reinvestment Rate RiskThe risk that if there is a substantial fall in the market’s interest rate, then there won’t be too many options to further invest (at the same rate) the interest received from the bond.
When is a good time to invest?
Bond prices fluctuate depending on the acceptable interest rate prevalent in the market. The term used for this is yield. For example – A bond with a coupon rate of 8% and face value ₹100, has a yield of 8% at the time it is issued 3assuming it is issued at face value . If someone is willing to buy this at ₹102 (and earn 8% on face value ₹100 = ₹8) the yield of the bond to such a buyer is ₹8/102 = 7.84%.
Based on this, a good time to invest is when one finds a bond the yield of which is better than what is available from other investment avenues available to such investor, while considering the risk factor of all alternatives. One must also consider the credit worthiness of the issuer of the bond.
How do I pick between a Debt Mutual Fund and a specific bond?
This depends on the preference of the investor. It’s the same as buying a hamper of chocolates. Either you trust the mix of chocolates selected by the person assembling the hamper, or if you know your chocolates well, pick and choose as you please. 🙂
Where can I get started?
To get started, please open your account by clicking here.