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Bond/NCD is a kind of debt which is taken by an issuer for financing a money requirement raised, generally, these instruments consist of fixed coupon payment and the fixed maturity date on which principal payment is being made. Here the issuer may be anyone like Government, State governments, Trusts, companies, Municipalities, etc.
How It Works
There are two methods of buying a bond.
- Primary (Directly from Issuer)
- Secondary (From the secondary market on Exchange)
Buyers need to be aware of two primary aspects, market price and yield. The market price is what is quoted on an exchange for buying or selling, and the yield shows what you earn every year by holding the bond. The latter is calculated by dividing the annual coupon or interest rate by the market price. Stocks are bought with the expectation that price rise will lead to profits. In bonds, however, the buy price is not always lower than the face value of the bond that you get back at maturity. What really matters is the yield.
Bond prices rise when yields fall, and vice versa. For example, a bond issued at Rs100 with a 10% coupon and maturity of 2 years is sold at the end of year 1 at Rs101. This is a yield of 9.9% and makes for 11% return (Rs1 on the price + Rs10 coupon). At the end of the next year, the buyer gets back Rs100 principal and Rs10 as coupon, but that is not a return of 10%, rather it is 9%, because you paid Rs101 to acquire the bond. If you had bought when the yield was low, chances are you won’t be able to profit much as a rising yield means lower prices. If the trend is for yields to move lower, then the opposite is likely to occur.
Types of Bonds /NCD
Tax-Free Bonds
Tax free bonds are generally issued by a government enterprise to raise funds for a particular purpose. Tax free bonds are among the few instruments in the country, where the interest earned is tax free in the hands of investors. These bonds are sought after among high net worth individuals, who are in the highest tax bracket.
Capital Gain Bonds
Capital gain bonds or 54EC bonds are the fixed income instruments that provide capital gains tax exemption under section 54EC to the investors. The tax liability on long-term capital gains from sale of immovable property can be reduced by purchasing 54EC bonds.
Corporate Bonds
Corporate Bonds are Bonds issued by private or public sector companies in order to borrow funds from the market. Corporate Bonds can be issued by way of Public issue where the retail investors as well as institutions can participate in the issue or by way of Private Placement where only a limited number of investors participate in the issue. They are generally issued for a period of 1 year to 20 years and they can also be Listed.
GOI Bonds
Government bonds, also referred to as government securities or G-Sec, are debt instruments issued by the Central or State governments to raise money through investors for meeting their capital expenditures. In this debt-based investment, you loan money as a creditor to a government in return for an agreed rate of interest on the amount at regular intervals. The funds raised with government bonds are used for expenditure on new projects like infrastructure, roads, schools, etc.
Secured NCDs: Secured NCDs are those NCDs that are backed by the issuer company’s assets.
Unsecured NCDs: When the NCDs are based only on the creditworthiness of the issuer and not backed by assets, they are called unsecured NCDs.
Is it Safe to Invest in Bonds
Bond investments are considered safe relative to equity investments but there are factors that should be checked in to understand the safety.
Prevailing interest rates: Bond prices generally move in the opposite direction of prevailing interest rates. If interest rates are falling, bond prices are generally rising. In a rising interest rate environment, bond prices will generally fall.If you are looking to benefit from a trade, buy when the yield is high with the expectation to sell when it is low.
Age of the bond: The longer the maturity, the larger the swing in price in relation to interest rate movements. In a period of rising rates and declining prices, the long-term bond funds will decline in value more than intermediate-term and short-term bonds.
Credit quality: Credit Rating is an important factor that affects the bond prices and yields just like an individual wanting to get a loan, bond issuers must generally pay higher interest rates if their credit rating is poor. Therefore bond investors must ensure the credit quality of the issuer.
Bonds Advantages and Disadvantages
Advantages
Fixed Returns on Investment: Bonds are fixed investment that pays out regular interest at regular times. Furthermore, when a bond matures, you receive the principal amount deposited before. The nicest thing about investing in bonds is that investors know precisely how much money they will get back.
Less Risky: Although both bonds and stocks are securities, the major distinction is that the former matures after a certain length of time, whilst the latter generally remains outstanding indefinitely. In the event of liquidity, bondholders are paid first, followed by shareholders.
Less volatile: Bonds are safer to invest in than stocks, which come with their own set of dangers. Although the value of a bond might change depending on current interest rates or inflation rates, they are typically more stable than stocks.
Clear Ratings: Bonds, unlike equities, are assessed by credit rating organizations globally. This reassures investors that now is the best moment to invest in bonds and gives a clear picture about how risky a bond can be. Credit Rating agencies provide good insights regarding particular bonds. However, before investing, it’s still a good idea to do your own research.
Disadvantages
Larger Investment needed: One of the most common drawbacks of bonds is the expense of acquiring them.Thus high minimum Investment in Bonds whether primary or secondary is required which varies between ten thousand to 1 crore, it creates an entry barrier for small investors.
Credit Risk: If a firm goes bankrupt, bondholders may lose a significant portion or all of their investment.
Less liquid compared to stocks: Although most big firms have strong liquidity, bonds issued by smaller or less financially sound companies may have lower liquidity since fewer investors are prepared to purchase them.
Suitability
Investing in bonds/NCDs is suitable for those investors who are seeking regular income or a conservative approach. Also it can be suitable according to the investors’ needs from time to time.
Taxation
Interest Income is added to an individual’s income and taxed accordingly. While Capital gain on Bond will be taxed at 20% along with indexation benefit after 1 year and as per income slab if sold within 1 year.
Frequently Asked Questions (FAQs)
1. Who can Invest in Bonds?
Any person resident of India is eligible provided with necessary documents and KYC requirements.
2. Why it is Better to Invest in Bonds?
Bonds provide Fixed Returns on Investment as well as they are less volatile and risky compared to stocks. Investors also have an exit option to sell certain bonds on exchange.
3. How Liquid is the Secondary Market Bond?
It varies with respect to the issuing company. There are various features of bonds, one being liquidity. However, it must be kept in mind that generally high credit quality companies’ bonds possess good liquidity in nature.
4. Can I Withdraw the Bonds?
Yes, certain bonds in the secondary market are traded on exchange and can be sold there, however, it will depend on liquidity.
