Understanding the Types of Bonds: A Beginner’s Guide to Bond Investing

Navigating the stock market can be a rollercoaster ride, with its exhilarating highs and daunting lows. While the allure of high returns is tempting, the volatility can be overwhelming for many investors. In contrast, bonds offer a haven of stability, providing a predictable and steady income stream. As a cornerstone of a well-diversified portfolio, bonds can balance the uncertainties of the stock market, ensuring a smoother investment journey but understanding the different types of bonds is critical to make the right investment decision.

The Indian bond market has seen an impressive surge, growing by over 77% in the last five years to reach a staggering total market value of Rs. 205.30 lakh crores. This remarkable growth underscores bonds’ increasing popularity and importance in India’s financial landscape. This article will delve into the fundamentals of bonds, explore the various types available in India, and guide you on investing in bonds effectively.

But before we understand the types of bonds, let us know what bonds mean.

In simple terms, bonds are loans taken by an issuer from the investor. The issuer can be the government, a company, or a financial institution. In return for the loan, an investor gets periodic interest and principal on maturity from the issuer. Hence, a bond is a fixed-income security that offers stability to investors based on their risk appetite.

The Indian Bond Landscape: Types Of Bonds

India’s bond market offers various bonds with distinct features and investment objectives. Here are the primary types of bonds based on their issuers:

Government Bonds

Issued by the central or state government, these bonds are considered the safest due to their zero credit risk. Government bonds constitute 78% of the total bond market in India. They include:

• Treasury Bonds: These are issued by the central government. They pay a fixed interest and can have a maturity period between 10 and 30 years.
• Inflation-Indexed Bonds: As the name suggests, these bonds protect against rising prices by adjusting principal and interest according to inflation. The government mainly issues these.
• State Development Loans (SDLs): These bonds fund state infrastructure projects. SDLs offer higher returns from government securities while offering safety. The tenure and interest rate may vary from state to state.
• Sovereign Gold Bonds (SGBs): These bonds are issued by RBI on behalf of the government. SGBs are an alternative to physical gold as an investment and have denominations in grams of gold. It has an 8-year maturity with an option to exit after five years. SGBs offer a 2.5% fixed annual interest rate on the initial investment.
• RBI Bonds (The Floating Rate Savings Bond): The RBI issues these bonds as taxable bonds. They have a maturity of 7 years and a floating interest rate adjusted every six months. Hence, the interest is paid every six months rather than at maturity.
• Treasury Bills: These bonds have maturities of 91 days, 182 days and 364 days. Hence, treasury bills are liquid short-term government securities with low risk. Usually, they are issued at a discount and redeemed at face value.

Corporate Bonds

Companies issue corporate bonds to borrow money for capital requirements. These offer a higher yield than government bonds but are riskier as well. The maturity and interest rate also vary depending on the issuer’s creditworthiness. These can be further classified into:

• Public-sector Undertaking (PSU) Bonds: These are issued by state-owned companies, so they are safer than private-sector corporate bonds. 
• High-Yield Bonds: These are issued by companies with lower creditworthiness. Hence, they are also referred to as junk bonds as they offer higher returns due to high risk. Such bonds carry a very high risk of default.

Other Types Of Bonds

The Indian bond market contains various other kinds of bonds, such as:

• Floating-Rate Bonds: These bonds offer a variable rate adjusted periodically based on benchmark rates such as the repo rate. They protect investors from interest rate risk due to market fluctuations.
• Mortgage-Backed Securities: Real-estate companies pool various mortgages and issue these bonds against the underlying mortgage pool.
• Zero-Coupon Bonds: These are issued at a discount and offer a fixed return at maturity without periodic interest payments. The difference between the issue price and face value is the return.
• Perpetual Bonds: These bonds have no defined maturity date and pay periodic fixed or floating interest till perpetuity.
• Callable Bonds: These bonds offer both the issuer and investor the option to redeem the bond before maturity.
• Convertible Bonds: These hybrid bonds offer debt and equity features but not simultaneously. Hence, an investor can convert their bonds into certain shares and become a shareholder afterwards.

Having explored the diverse types of bonds available in India, it’s essential to understand why bonds stand out as a strategic investment choice. Before we delve into investing in bonds, let’s highlight the distinctive features that make bonds a cornerstone of any sophisticated investment portfolio.

Features: Why Invest in Bonds?

Bonds offer distinctive features that prioritise stability with regular income.

• Regular Returns: Bonds offer periodic interest payments. Either fixed or floating. Hence, it is a reliable source of income.
• Stability: Bonds are less prone to market fluctuations than stocks. Hence, they offer stability to risk-averse investors.
• Capital Security: Bonds are considered safe investments that return the principal at maturity.
• Diversification: Bonds reduce the overall risk of the portfolio by infusing stability. Hence, they are essential for a well-balanced investment strategy.
• Tax Benefits: Certain bonds offer tax exemption on the interest earned. Hence, they are an attractive option for earning returns while gaining tax benefits.

Why invest in different types of bonds

Process: How To Invest In Bonds?

After understanding the compelling features of bonds, it is time to incorporate them into your portfolio. Let’s understand how to invest in bonds with the following steps:

1. Define Your Investment Goals: Assess your financial goals, risk tolerance, and investment horizon. These will help you identify the right bond as per your investment goals.
2. Research: Before investing, research the bond’s maturity, interest rate, and issuer’s creditworthiness. Analyse the bond thoroughly to make an informed decision.
3. Open A Demat Account: You can open a demat account with the help of a broker or a financial institution. With an active demat account, you can buy and sell bonds in the secondary market.
4. Order: Place the bond order with your broker or financial institution. The minimum investment amount will differ based on the type of bond.
5. Hold: Hold the bond till maturity to receive periodic interest rates and principal amount. 
6. Monitor: Keep in touch with your bond’s performance and readjust accordingly.

As you can see, investing in a bond is a relatively straightforward process. 

The Indian bond market has evolved to cater to various financial goals, offering stability, predictable income, and diversification. Bonds are an essential component of a well-balanced investment strategy. By incorporating bonds into your portfolio, you can achieve greater financial stability and reach your investment objectives faster. Start exploring the bond market today and take the first step towards a more diversified and secure financial future. You can invest in corporate bonds in India via various OBPs like Aspero – sign up now to explore.