Types of Bonds
A bond is a fixed-income debt instrument. Investors who loan a certain amount of money to a business expect a return on their investment or loaned amount. The borrower promises to pay the bearer of the bond an interest income on the amount lent.
Basics of Different Types of Bonds
A bond is debt security for investors and a debt obligation for the entities in which they invest. They are contractual obligations between the investor and borrower wherein the borrower promises to pay the entire principal, the invested amount, and a particular return when the bond matures.
To a bond issuer, bonds are liabilities or obligations employed for acquiring short-term financing. Bonds are generally issued in primary markets by governments & corporations to raise money. Institutional investors such as mutual funds, hedge funds, commercial banks, insurance companies, etc., are buyers in the primary market. The bond issued is then traded in the secondary market or stock exchanges at a certain coupon rate, where individual investors in public get to trade in them through brokers, intermediaries between investors and businesses.
Bonds are considered secure investments as they are less risky than their equity counterparts. However, risks arise if the borrowing entity fails to repay the bond value and/or profit. Also, bond prices & interest rates can fluctuate, causing bond yields to fluctuate. Bondholders then trade those bonds in the secondary market or stock exchanges for bonds with better coupon rates.
What are Different Types of Bond Categories?
There are primarily four categories of bonds issued in Indian primary markets.
1. Corporate Bonds
Companies issue corporate bonds. Bonds are an excellent way for companies to raise money and get short-term funding from the public at low-interest rates and with significant benefits. Corporate bonds provide higher yields than government bonds, but their prices and yields are susceptible to interest rate risk, credit risk, and inflation risks.
2. Municipal Bonds
Municipal bonds are a form of government bonds issued by city or town municipalities. Though they pose higher risks than government bonds but lower than corporate bonds, government and municipal bodies generally pose zero risk of default or bankruptcy. But, they do suffer from inflation risk.
3. Government Bonds
Issued by central and state governments, government bonds in India are regulated directly by the Reserve Bank of India. As the country’s administrative bodies issue them, risks are nearly non-existent. Three subcategories of government bonds include bills ( less than one year maturity period), notes ( 1 to 10 years maturity period) and bonds ( maturity period more than 10 years).
4. Agency Bonds
Government-sponsored enterprises issue agency bonds. They are a subcategory of government bonds and come with greater credit risks. However, the risks associated are generally lower than a corporate bond of an equivalent amount, interest rate, and other key features.
5. Asset-Backed Securities
Asset-backed securities are debt securities linked to pools of asset-backed loans. Mortgage-backed securities are one of the most common types of asset-backed securities. Investors buy mortgage bonds linked to pools of secured bank loans offered by financial institutions. Mortgage-backed securities have house or land mortgages as primary securities or collateral.
Now, look at the various types of bonds issued and traded in India.
What are the Different Types of Bonds?
The most generic type of bond, a traditional bond, allows bondholders to withdraw the entire principal amount at maturity.
A callable bond can be called out by the bond issuer at their discretion and redeemed before its maturity date. The bond issuer may also transform a high-debt bond into a low-debt bond.
Callable bonds are high-yield or junk bonds, which assure high returns but have a higher risk of default due to the poor credit rating of the bond issuer.
Important Features of a Bond
Every different type and category of bond shares certain characteristics. Here they are in no particular order.
The bond issuer is the organization that makes the initial public offering in the primary market. Governments, municipality bodies, and businesses are common bond issuers.
For all types of bonds, the face value or par value is the principal amount to be paid to the bondholder by the issuer at the time of maturity. Unlike bond prices, face values do not fluctuate and are not subject to market risks.