In July 2023, the Uttar Pradesh government said the civic bodies of four smaller cities in the state – Agra, Kanpur, Prayagraj and Varanasi – planned to issue municipal bonds by the year-end to raise money from the market to finance sewerage and water supply projects.
Bonds are issued by the central government and the states regularly to raise funds for infrastructure projects. But what makes this move stand out is that this will be the first time that tier-2 cities in North India will have taken the bond route for funds.
If governments and state agencies are looking at bonds to raise finances for public projects, one may wonder: so exactly what are bonds?
This is what we will explore in this blog, and also see how bonds function.
What Are Bonds?
Bonds are fixed-income instruments that represent a loan made by an investor to a borrower. Usually, bonds are issued by are the government, government bodies, and corporates to finance their projects and operations. In other words, these entities are borrowers, and the investors who invest in these bonds are effectively lenders.As bonds are basically loans, the investors receive interest at specified rates and times till the time the principal becomes due which is then returned to the investor. The bonds are deemed fixed-income instruments as investors earn interest at a fixed rate on their investment.
Bonds also have relatively lower risk and can be a good option to consider in India for those seeking investment avenues that spell steady income.
But before we get into discussing bonds and types of bonds, let us understand some keywords that are frequently used in discussions related to this instrument.
Important Bond Terms
Coupon Rate: Bondholders or investors receive interest against the money that they have lent to the borrower. The rate of interest on such bonds is called a coupon rate. For example, a bond with a coupon rate of 8% means the rate of interest offered is 8% annually.Face Value: Face value is the price of the bonds (and shares) as fixed by the issuing entity, and is not influenced by market fluctuations. This is what makes it different from market value, which is affected by market conditions..
Bond yield: This is the return on your investment in the bond. So after you buy a bond, you will earn a certain predetermined amount as interest over the bind’s entire lifespan. Additionally, when the bonds mature, the issuer will also pay you their total face value.
Bond yield is inversely related to the bond price – when the price rises, the bond yield falls, and vice versa.
There are some other terms that you should understand when discussing bond yields; some of these are coupon yield, current yield, and yield-to-maturity. Let us understand those.
Coupon yield: Also known as the coupon rate, this is the annual interest rate that was stated at the time of issuing the bond; as mentioned earlier, this rate does not change during the bond’s lifespan.
Current yield: This is the bond's coupon yield divided by its current market price meaning it will change if there is any change in the current market price. It is expressed as a percentage of its market price.
Say you buy a Rs 1,000 bond in the primary market (i.e. at the time it was issued) and receive Rs 45 as annual interest payments, your coupon yield is 4.5%, which is also the current yield as long as the price remains constant at Rs 1,000. Now let us assume the price has gone up by Rs 103 and is being at traded at Rs 1,030 in the open market, then the current yield drops to 4.37%.
Current yield becomes important for you if your aim is to sell the bond before it matures. But if it is a new bond that you have bought at par and held it till it matures, your current yield and the coupon yield will be the same at the tie of maturity.
Yield to maturity: This is the overall interest rate you would have earned had bought at the market price (as opposed to buying on par) and held it till maturity.
Credit Rating: Just like you have a credit score that represents your credit history and helps you borrow money from financial institutions easily, companies too have credit ratings which represent their creditworthiness and the default risk that they carry. Such credit rating is given by recognised rating agencies after investigating factors like a company’s financial performance, outlook, and past credit history.
The higher the credit rating of a company, the easier it is for them to obtain money from investors. The lower coupon rates they offer also falls. Likewise, companies with lower credit ratings find it difficult to find investors and are likely to offer higher coupon rates to compensate for the increased risk.
Types Of Bonds
There are various types of investment bonds that an investor can invest in depending on their goals and their risk appetite. Let us look at some of these.Government Bonds
Government bonds, as the name suggests, are bonds issued by the government (central or state). Such bonds have the highest credit rating as they carry a sovereign guarantee and are therefore considered low risk instruments. The return they offer is also lower.PSU Bonds
Bonds that are issued by public sector companies in India are called PSU bonds. Such bonds just like government bonds are safer than corporate bonds and offer investors stability in their portfolios.Corporate Bonds
Companies that borrow capital from the credit market issue corporate bonds. They are also called debentures. As these bonds are issued by private companies, they carry a higher risk than government bonds or PSU bonds. As a result, the returns on such bonds are a little higher than the government bonds.How much risk such bonds carry depends on the issuing company and the industry it is present in. Hence, while investing in corporate bonds, an investor needs to do due diligence about the company’s fundamentals.
Municipal Bonds
The local bodies of governments issue municipal bonds to fund development projects like building schools, hospitals, bridges, etc., in towns and cities. The Uttar Pradesh tier-2 cities mentioned earlier issued these bonds. Such bonds have a maturity period of three years, and they even carry tax benefits for the investor.Zero-Coupon Bonds
Zero-coupon bonds are those that do not offer the investors any earnings in the form of interest. As the name suggests, the coupon rate is zero.What makes them lucrative for investment is this: when zero-coupon bonds are issued, they are issued at a discount to the face value of the bond. Investors earn returns in the form of the difference between the issue price and the maturity price. It is similar to bonds that pay accrued interest at the maturity date rather than paying it regularly.
Floating Rate Bonds
Some bonds offer a fixed rate of interest over and above a benchmark that is variable. An example would be the RBI Floating Rate Savings bonds, popularly known as RBI bonds, which are linked to the National Savings Certificate (NSC) scheme.This bond offers the investors an interest rate of 0.35% over and above the prevailing interest rate in NSC. In the April-June 2023 quarter, the interest rate in NSC was 7.7%. This meant investors in the RBI bonds were offered 8.05% (7.7% + 0.35%).
Investors invest in floating rate bonds to take benefit of changing interest rates.
Inflation Linked Bonds
Inflation-linked bonds are a variant of floating rate bonds designed to help investors protect themselves from the effect of inflation. These bonds are linked to the country’s inflation index i.e. the Consumer Price Index (CPI), to adjust itself according to the inflation rate in the economy. Such bonds not only adjust the coupon rates with changes in inflation, these also adjust their face value accordingly.Perpetual Bonds
Bonds that are issued by an entity with no maturity date are called perpetual bonds. These do not come with a maturity date but instead offer the investors perpetual interest, thus offering them a stable interest income for their lifetime.Most perpetual bonds come with a call option. This enables the borrower to call back the bonds by redeeming them at a predetermined price.
Callable and Puttable Bonds
Some bonds come with put options; they are called callable bonds and puttable bonds.The callable bonds have an in-built call option wherein the issuing company can call the bonds back from the investors and redeem them at a pre-determined price. This way, companies can redeem when the interest rates drop which allows them to get funds at cheaper rates.
Similarly, puttable bonds have an in-built put option wherein the investors can execute the put option and redeem their bonds before their maturity date. They do so when the interest rates are high and they can invest their money at a higher interest rate. However, puttable bonds are not so common these days.
Interest Rates and Bonds Prices
Bond prices and interest rates have an inverse relationship; when rates go up, bond prices fall, and when rates go down, bond prices rise.To understand why this happens, let us assume you hold a bond with a face value of Rs 1,000 offering a coupon rate of 5% annually. Guess what happens when a year down the line, interest rates rise?
This is what will likely happen: any fresh bond with a matching face value of Rs 1,000 will likely offer coupon rates higher than yours – say at 6%. Why? Because companies that now want to borrow funds from the market will be forced to match the higher interest rates that banks are offering.
This will have an immediate impact on your bond: its value will start dropping; you will realise this if you try to offload your bond in the secondary market – chances are that you will have to sell it at a discount, i.e. under Rs 1,000.
Risks involved with bonds
Like any financial instrument, bonds carry certain risks as well. Let us explore these:Default Risk
Bonds represent loans given by the investor to the issuing company. Hence, they carry a default risk wherein the borrower could default on the payments of interest and even principal due to liquidity issues.Almost all bonds issued by entities other than the government (central or state) carry default risk. This brings the creditworthiness of the borrower under question, and also explains why credit ratings is an important factor while determining the default risk in a bond.
Interest Rate Risk
One important risk with bonds that investors should be aware of is interest rate risk. As already explained, interest rates and bond prices are inversely related; if interest rates go up, bond prices go down. Of course, you won’t face actual loss if you plan to hold the bonds till maturity. But it will be a loss of opportunity as you could have earned a higher interest if you had invested in bonds that offer a higher interest rate.Liquidity Risk
It may so happen that when you try to sell your bonds, you are not able to find a buyer. In other words, there is a risk that you won’t be able to get your money when you require it.What To Consider Before Investing in Bonds?
Consider the following when evaluating bonds:- Security: Check if the bond is secured or unsecured (secured bonds are backed by company assets and offer slightly lower rates but greater safety).
- Liquidity: Assess the bond’s liquidity; traders are limited so check for sufficient exit options if you don't intend to hold the bond until maturity.
- Coupon Rate: Verify if the bond's interest rate is competitive, as bonds with coupon rates significantly lower than market rates tend to trade at a discount.
- Credit Rating: Evaluate the bond's credit rating, with AAA bonds being the safest but potentially offering lower yields. Lower rated bonds may provide higher yields but come with increased risk.
- Callability Clause: Check if the bond has a callability clause, where the issuer can redeem the bond if market interest rates decline sharply. This may impact long-term financial planning relying on high yields.
- Post-Tax Yields: Remember that bond interest is taxable. Explore tax-free infrastructure bonds like those issued by REC and PFC, which offer entirely tax-free interest.
Conclusion
Investors who don’t want to take up higher risks by investing in equity or investors who wish to reduce their portfolio risk by diversifying can choose to invest in bonds. But it is advisable to consulting a qualified financial advisor before investing.FAQs – Frequently Asked Questions
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What is an investment grade bond
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Are interest rates and bond prices related ?
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What do junk bonds mean ?
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Can I redeem my bonds before they mature ?
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Which is better, high-yield bonds or low-yields ?
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Are bonds riskier than equity investments ?
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Is there any maximum or minimum price for bonds ?
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Which individuals can benefit from bond investments ?
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How are bond investments different from equity ?
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The Facilities Provider or ABCL or ABC Companies does not routinely monitor your postings to the Website but reserves the right to do so if deemed necessary if it is related to the facilities offered on the web site and to comply with law. However, in our efforts to promote good citizenship within the internet community, if the Facilities Provider or ABCL or ABC Companies becomes aware of inappropriate use of the Website or any of its facilities, any information, opinions, advice or offers posted by any person or entity logged in to the Website or any of its associated sites is to be construed as public conversation only, and the Facilities Provider or ABC Companies shall not be liable or responsible for such public conversation. You agree that in such cases, we will respond in any way that, in our sole discretion, as deemed appropriate. You acknowledge that Facilities Provider or ABC Companies will have the right to report to law enforcement authorities any actions that may be considered illegal, as well as any information it receives of such illegal conduct. When requested, ABC Companies/Facilities Provider will co-operate fully with law enforcement agencies in any investigation of alleged illegal activity on the internet.
Submissions and unauthorized use of any Materials contained on this Website may violate copyright laws, trademark laws, the laws of privacy and publicity, certain communications statutes and regulations and other applicable laws and regulations. You alone are responsible for your actions or the actions of any person using your user name and/or password. As such, you shall indemnify and hold Facilities Provider, ABCL / ABC Companies and its officers, directors, employees, affiliates, agents, licensors, and business partners harmless from and against any and all loss, costs, damages, liabilities, and expenses (including attorneys' fees) incurred in relation to, arising from, or for the purpose of avoiding, any claim or demand from a third party that your use of the Website or the use of the Website by any person using your user name and/or password (including without limitation your participation in the posting areas or your submissions) violates any applicable law or regulation, or the rights of any third party.
We reserve the right to terminate access to this Website at any time and without notice. Further this limited license terminates automatically, without notice to you, if you breach any of these Terms of Use. Upon termination, you must immediately destroy any downloaded and printed Materials.
If you come across any breaches/violation or offensive material you must report to us at abc.secretarial@adityabirla.com
Use of Cookies
You agree and understand that the Website will automatically receive and collect certain anonymous information in standard usage logs through the Web server, including computer/computer resource-identification information obtained from "cookies" sent to your browser from a web server or other means as explained in the Privacy Policy.
Facilities Changes and Discontinuation
The Website reserves the right to discontinue or suspend, temporarily or permanently, the facilities. You agree that the Facilities Provider/ ABC Companies will not be liable to you in any manner whatsoever for any modification or discontinuance of the facilities. The format and content of this Website may change at any time. We may suspend the operation of this Website for support or maintenance work, in order to update the content or for any other reason.
ABCL, ABC Companies, and its directors, employees, associates, or other representatives shall not be liable for any damages or injury, arising out of or in connection with the use, or non-use including non-availability of the Website and also for any consequential loss or any damages caused because of non-performance of the system due to a computer virus, system failure, corruption of data, delay in operation or transmission, communication line failure, or any other reason whatsoever. The Website will not be responsible for any liability arising out of delay in providing any information on the Website.
Compliance with the Law
You agree that you will not:
- Use any robot, spider, scraper, deep link or other similar automated data gathering or extraction tools, programme, algorithm or methodology to access, acquire, copy or monitor the Website, or any portion of the Website.
- Use or attempt to use any engine, software, tool, agent, or other device or mechanism (including without limitation, browsers, spiders, robots, avatars or intelligent agents) to navigate or search the Website, other than the search engines generally available by third party web browsers
- Post or transmit any file which contains viruses, worms, Trojan horses or any other contaminating or destructive features, or that otherwise interferes with the proper working of the Website or the facilities.
- Attempt to decipher, decompile, disassemble, or reverse engineer any of the software, comprising or in any way making up a part of the Website or the facilities.
- You agree not to use the facilities for illegal purposes or for the transmission of material that is unlawful, harassing, libelous (untrue and damaging to others), invasive of another's privacy, abusive, threatening, or obscene, or that infringes the rights of others.
Restrictions on Commercial Use or Resale
Your right to use the facilities is personal to you; therefore, you agree not to resell or make any commercial use of the facilities. In addition, the Website welcomes your feedback as a user of the facilities. Any feedback you provide will become the confidential and proprietary information of the Website, and you agree that the Website may use in any manner and without limitation, all comments, suggestions, complaints, and other feedback you provide relating to the Website. The Website shall have a worldwide, royalty-free, non-exclusive, perpetual, and irrevocable right to use feedback for any purpose, including but not limited to incorporation of such feedback into the Website or other Website software or facilities.
No Endorsements
All product and facilities marks contained on or associated with the facilities that are not the Website marks are the trademarks of their respective owners. The Website would require you to respect the same. References to any such names, marks, products or facilities of third parties or hypertext links to third party sites or information does not imply the Website’s endorsement, sponsorship or recommendation of the third party, information, product or facilities.
Promotional Offers
You may receive from time to time, announcement about offers with intent to promote this Website and/or facilities/products of ABC Companies (“Promotional Offers”). The Promotional Offer(s) would always be governed by these Terms of Use plus certain additional terms and conditions, if any prescribed. The said additional terms and conditions, if prescribed, would be specific to the corresponding Promotional Offer only and shall prevail over these Terms of Use, to the extent they may be in conflict with these Terms of Use. The Website reserves the right to withdraw, discontinue, modify, extend and suspend the Promotional Offer(s) and the terms governing it, at its sole discretion.
Charges for use of Website
There are no charges or fees to be paid by you for use of this Website. However, you are responsible for all telephone access fees and/or internet service fees that may be assessed by your telephone and/or internet service provider. You further agree to pay additional charges, if any levied by Third Party Service Provider(s), for the facilities provided by them through the Website (Additional Charges).
No Endorsement
You are advised to be cautious when browsing on the internet and to use good judgment and discretion when obtaining information or transmitting information. From this Website, users may visit or be directed to third party web sites. The Website makes no effort to review the content of these web sites, nor is the Website or its licensors responsible for the validity, legality, copyright compliance, or decency of the content contained in these sites.
In addition, the Website does not endorse or control the content of any other user and is not responsible or liable for any content, even though it could be unlawful, harassing, libelous, privacy invading, abusive, threatening, harmful, vulgar, obscene or otherwise objectionable, or that it infringes or may infringe upon the intellectual property or other rights of another. You acknowledge that the Website does not pre-screen content, but that the Website will have the right (but not the obligation) in their sole discretion to refuse, edit, move or remove any content that is available via the facilities.
Electronic Communications
These Terms of Use and any notices or other communications regarding the Facilities may be provided to you electronically, and you agree to receive communications from the Website in electronic form. Electronic communications may be posted on the Website and/or delivered to your registered email address, mobile phones etc either by Facilities Provider or ABC Companies with whom the services are availed. All communications in electronic format will be considered to be in "writing". Your consent to receive communications electronically is valid until you revoke your consent by notifying of your decision to do so. If you revoke your consent to receive communications electronically, the Facilities Provider shall have the right to terminate the facilities.
Assignment
You shall not assign your rights and obligations under this Agreement to any other party. The Website may assign or delegate its rights and/or obligations under this Agreement to any other party in future, directly or indirectly, or to an affiliated or group company.
Legal Disclaimers
The information provided on or through the Website is for general guidance and information purposes only and they do not in any manner indicate any assurance or opinion of any manner whatsoever. Any information may be prone to shortcomings, defects or inaccuracies due to technical reasons. Certain information on Website may be on the basis of our own appraisal of the applicable facts, law and regulations in force at the date hereof.
The information (and opinions, if any) contained on the Website may have been obtained from public sources believed to be reliable and numerous factors may affect the information provided, which may or may not have been taken into account. The information provided may therefore vary (significantly) from information obtained from other sources or other market participants. Any reference to past performance in the information should not be taken as an indication of future performance. The information is dependent on various assumptions, individual preferences and other factors and thus, results or analyses cannot be construed to be entirely accurate and may not be suitable for all categories of users. Hence, they should not be solely relied on when making investment decisions. Your investment or financial decision shall always be at your own discretion and based on your independent research; and nothing contained on the Website or in any information would construe ABCL/ABC Companies or any of its employees/authorized representative as having been in any way involved in your decision making process. Any information and commentaries provided on the Website are not meant to be an endorsement or offering of any stock or investment advice.
Nothing contained herein is to be construed as a recommendation to use any product, process, equipment or formulation, in conflict with any patent, or otherwise and Facilities Provider / ABCL/ABC Companies makes no representation or warranty, express or implied that, the use thereof will not infringe any patent, or otherwise. Information on this Website sourced from experts or third party service providers, which may also include reference to any ABCL Affiliate. However, any such information shall not be construed to represent that they belong or represent or are endorsed by the views of the Facilities Provider or ABC Companies. Any information provided or sourced from ABCL Affiliate belongs to them. ABCL is an independent entity and such information from any ABCL Affiliate are not in any manner intended or to be construed as being endorsed by ABCL or Facilities Provider. The information does not constitute investment or financial advice or advice to buy or sell, or to endorse or solicitation to buy or sell any securities or other financial instrument for any reason whatsoever. Nothing on the Website or information is intended to constitute legal, tax or investment advice, or an opinion regarding the appropriateness of any investment or a solicitation of any type. Investment in the securities market and any financial instruments are inherently risky and you shall always assume complete and full responsibility for the outcomes of all the financial or investment decisions that you make, including but not limited to loss of capital. You are therefore advised to obtain your own applicable legal, accounting, tax or other professional advice or facilities before taking or considering an investment or financial decision.
No Solicitation
No Information at this Website shall constitute an invitation to invest in ABCL or any ABC Companies. These are meant for general information only or to meet statutory requirements or disclosures. ABCL or any of its employees are in no way liable for the use of the information by you, when making any decision or investing or trading through any investment vehicles or ABC Companies, or any other third party which may be engaged in offering of these services.
The information contained on this Website does not represent and should not be used to construe (i) the terms on which a new transaction would be entered into by ABCL or ABC Companies, (ii) the terms on which any existing transactions could be unwound by ABCL or ABC Companies, (iii) the calculation or estimate of an amount that would be payable following an early termination of any past/existing transactions or (iv) the valuations given to any transactions by ABCL or ABC Companies in their books of account for financial reporting, credit or risk management purposes.
Statutory Disclosure
ABCL and ABC Companies are engaged in a broad spectrum of activities in the financial services sectors. You understand and acknowledge that Aditya Birla Money Limited (‘ABML’), Aditya Birla Finance Limited (‘ABFL’) and Aditya Birla Sun Life Asset Management Company Limited and trustees and sponsor of Aditya Birla Sun Life Mutual Fund (‘ABSLMF’) are group companies and ABML / ABFL also acts as a distributor of ABSLMF. Any recommendation or reference of schemes of ABSLMF if any made or referred on the Website, the same is based on the standard evaluation and selection process, which would apply uniformly for all mutual fund schemes. You are free to choose the execution facilities in the manner deemed fit and proper and no commission will be paid by ABSLMF to ABML / ABFL if you choose to execute a transaction with ABSLMF on the Website, unless otherwise agreed by you and ABML/ABFL separately. Information about ABML/ABFL, its businesses and the details of commission structure receivable from asset management companies to ABML/ABFL, are also available on their respective Website.
Similarly Aditya Birla Money Insurance Advisory Services Limited and Aditya Birla Insurance Brokers Limited are insurance intermediaries and engaged in the distribution of Insurance Products and it may services may include products of Aditya Birla Sun Life Insurance Company Limited and Aditya Birla Health Insurance Company Limited. However there is no conflict on these services and commissions if any payable are in accordance of the extant regulations.
Force Majeure
The Facilities Provider, ABC Companies and any of its Third Party Service Providers shall not be liable for any delay or failure in performance resulting directly or indirectly from acts of nature, forces, or causes beyond their reasonable control, including, without limitation, Internet failures, computer equipment failures, telecommunication equipment failures, other equipment failures, electrical power failures, strikes, virus, other malicious computer code, hacking, labour disputes, riots, insurrections, civil disturbances, shortages of labour or materials, fires, flood, storms, explosions, acts of God, war, earthquake, governmental actions, orders of domestic or foreign courts or tribunals, non-performance of third parties, or loss of or fluctuations in heat, light, or air conditioning.
Indemnification
You agree to protect and fully compensate Facilities Provider, ABCL, ABC Companies, subsidiaries, licensors, suppliers and facilities providers, employees, officers and directors, from any and all third party claims, liability, damages, expenses and costs (including but not limited to reasonable attorneys fees) caused by or arising from your use of the facilities, your violation of the Terms of Use or your infringement, or infringement by any other user of your account, of any intellectual property or other right of anyone.
No Waiver
The Facilities Provider, ABC Companies or any of its third party service providers and processor bank/merchants etc. shall not be deemed to have waived any of its/their rights or remedies hereunder, unless such waiver is in writing. No delay or omission on the part of Facilities Providers and ABC Companies, in exercising any rights or remedies shall operate as a waiver of such rights or remedies or any other rights or remedies. A waiver on any one occasion shall not be construed as a bar or waiver of any rights or remedies on future occasions.
Exclusive Agreement
You agree that these Terms of Use are the complete and exclusive statement of agreement supersede any proposal or prior agreement, oral or written, and any other communications between you and the Facilities Provider and its Third Party Service Providers or processor bank/merchants relating to the subject matter of these Terms of Use. These Terms of Use, as the same may be amended from time to time, will prevail over any subsequent oral communications between you and the Website and/or the processor bank.
Termination
Either party can terminate this Agreement by notifying the other party in writing. Upon such termination You will not be able to use the facilities of this Website.
Governing Law and Jurisdiction
The Website specifically prohibits you from usage of any of its facilities in any countries or jurisdictions that do not corroborate to all stipulations of these Terms of Use. The Website is specifically for users in the territory of India. In case of any dispute, either judicial or quasi-judicial, the same will be subject to the laws of India, with the courts in Mumbai having exclusive jurisdiction.
These Terms and Conditions are governed by and to be interpreted in accordance with laws of India, without regard to the choice or conflicts of law provisions of any jurisdiction. You agree, in the event of any dispute arising in relation to these Terms and Conditions or any dispute arising in relation to the Website whether in contract or tort or otherwise, to submit to the jurisdiction of the courts located at Mumbai, India for the resolution of all such disputes.
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