Introduction to Bonds: An Overview of How Different Bonds Work

A bond is a debt instrument issued by a company or the government to raise capital by borrowing from investors. Bond investors are debt holders (lenders/creditors), while the bond issuer is obligated to pay bondholders interest (the coupon) at a predetermined rate and repay the principal on the maturity date. Like bank deposit receipts, bond issuers provide standardized certificates to bondholders, though most are now electronic. Bonds, as debt securities, can be easily bought or sold in financial markets.

Characteristics of Bonds

Face Value: The face value is the amount returned to the investor when the bond matures. Bonds also pay a coupon amount, which is the interest paid annually.

Issuers: Bonds can be issued by companies or governments and typically offer a stated interest rate.

Ownership Rights: Unlike stocks, bonds do not confer ownership rights in the issuing company.

Term: The period from the bond’s issuance to its maturity. Bonds are categorized as short-term (under 4 years), intermediate-term (4-10 years), or long-term (over 10 years).

Purchasing Bonds: Bonds can be bought through brokers, mutual funds, exchange-traded funds (ETFs), or directly from governments.

Market Value: A bond’s market value fluctuates over time due to market conditions. However, if held to maturity, the bondholder receives consistent interest payments and the face value.

Interest Rates: Higher-rated bonds generally offer lower interest rates due to lower risk. Shorter-term bonds also tend to offer lower interest rates.

Types of Bonds

1. Government Bonds (Treasury Bonds): Issued by national governments and considered low-risk. They typically mature in 10 to 30 years and offer fixed interest rates.
2. Corporate Bonds: Issued by companies to raise capital. Interest payments and principal repayment depend on the company’s creditworthiness, assessed by credit rating agencies.
3. Municipal Bonds: Issued by local governments in India to fund public infrastructure projects like roads, schools, and hospitals. Also known as “muni bonds.”
4. Floating Rate Bonds: Bonds with interest rates that adjust periodically based on a benchmark rate (e.g., the Reserve Bank of India’s repo rate), protecting investors from interest rate risk.
5. Convertible Bonds: Corporate debt securities that pay interest but can be converted into a predetermined number of equity shares.
6. Negative Yield Bonds: Bonds where investors accept a return below the purchase price at maturity, anticipating deflation. Commonly purchased by institutional investors for liquidity or central bank operations. For more details read: Convertible bonds, floating bonds, and, negative bonds
7. Inflation-Protected Bonds: Issued by governments to protect investors from inflation. The interest rate is fixed, but the principal adjusts with the Consumer Price Index. To know more read: What is inflation indexed Bonds or IIB?
8. Junk Bonds: High-yield, high-risk bonds rated below investment grade, offering higher potential returns.
9. Zero-Coupon Bonds: Sold at a discount and pay no periodic interest. The bondholder receives the face value at maturity, with the discount serving as the bond’s interest. To know more read: What is a Zero-Coupon Bond?
10. Eurobonds, Foreign Bonds, and Global Bonds: International bonds issued by non-domestic entities. These bonds differ in currency denomination and regulatory environments. Explore more: What are foreign Bonds, Euro Bonds, and Global bonds? 
11. Masala Bonds: Rupee-denominated bonds issued outside India by Indian entities to attract foreign investment. Introduced by the International Finance Corporation in 2014.
12. Callable Bonds: Bonds that can be redeemed by the issuer before maturity, usually at face value plus accrued interest.
13. Coupon Bonds: Bonds that pay periodic interest to investors based on the bond’s face value. For example, a Rs. 5,000 bond with a 6% coupon rate pays Rs. 300 annually.
14. Foreign currency Convertible Bonds: A foreign currency convertible bond (FCCB) is a type of bond that is issued in a currency other than the issuer’s home currency. Foreign Currency Convertible Bonds (FCCBs) mean a bond issued by an Indian company expressed in foreign currency, and the principal and interest in respect of which is payable in foreign currency. Further, the bonds are required to be issued in accordance with the scheme viz., “Issue of Foreign Currency Convertible Bonds and Ordinary Shares (Through Depositary Receipt Mechanism) Scheme, 1993”, and subscribed by a non-resident in foreign currency and convertible into ordinary shares of the issuing company in any manner, either in whole, or in part, on the basis of any equity related warrants attached to debt instruments. The ECB policy is applicable to FCCBs. The issue of FCCBs is also required to adhere to the provisions of Notification FEMA No. 120/RB-2004 dated July 7, 2004, as amended from time to time. To know more Read :. What is a Foreign Currency Convertible Bond?
15. Mortgage Based Security: Mortgage Backed Security: A mortgage-backed security (MBS) is a bond type security in which the collateral is provided by a pool of mortgages. For example, A borrows money from Bank ‘B’ mortgaging his house to Bank ‘B’. The Bank ‘B’ sells the mortgage to a company ‘C’ (which may be a government agency or investment bank or private entity). The company ‘C’ groups similar mortgages ((i.e., similar interest rates, maturities, etc.) already bought by it. This system of grouping mortgages is known as pooling the mortgages. This way the companies like ‘C’ can purchase more mortgages and create MBS which will be sold to investors in a package similar to bonds in the open market. For investors an MBS is much like a bond which offers monthly, quarterly or half yearly income along with the principal. To know more read: What is MBS? and What is ABS?

To learn more about bonds, explore: Terms Associated with Bonds.