Types of Bonds Explained: A Simple Guide

There are various types of bonds available, and each one works in a different way. Some are safer, while others offer higher returns but come with more risk. If you are new to investing, it is important to understand the basic types of bonds before you decide where to put your money. In this article, we will explore what are different types of bonds and provide a simple overview of how to invest in bonds. 

List of Different Types of Bonds

Here are some of the most common types of bonds, along with their key characteristics: 

• Junk Bonds or High-Yield Bonds- These bonds come with a low credit rating and high interest rates, owing to a high ROI along with a higher possibility of running significant risks. 
• Perpetual Bonds– These bonds don’t have a defined maturity date and hence, the investor can hold the bond for as long as they wish. It’s best for long-term investments, considering that it does not have an expiration date and serves as a fixed source of income. 
• Fixed Rate Bonds: These bonds have a fixed deposit interest rate till their maturity. It is well suited for investors who are willing to lock in the money for a specific period at a fixed interest rate. This makes it a very reliable savings option with a pre-defined ROI.
• Floating Rate Bonds: These bonds have a dynamic interest rate that keeps adjusting at regular intervals, owing to the market rate. This primarily benefits an investor by protecting the bond from market fluctuations. 
• Zero-Coupon Bonds: These bonds don’t have any interest. Instead, such bonds are sold at a reasonably discounted price from the face value, offering a collective return instead of periodic earnings. 
• Convertible Bonds: These bonds come at a lower interest rate but offer equity since the bonds are allowed to be converted to cash or company shares. Having equity can benefit the investor if the company shows strong growth. 
• Callable Bonds: These bonds are best for the issuer since they can be redeemed before maturity, thereby paying less interest to the investor. Hence, to attract investors to buy such bonds, the interest rates are kept high.
• Putable Bonds: These bonds permit the investor to force the issuer to redeem the bonds before their maturity. These bonds can prevent investors from suffering a loss due to sudden market fluctuations by creating a convenient exit. 
• Inflation-Linked Bonds: These bonds are also known as inflation-indexed bonds and are formed to protect the investors from the negative impact of inflation. Similar to a floating rate bond, these bonds adjust their principal and interest rates as per inflation, thereby protecting against the risk.
• Government Bonds: These bonds are issued by the Central or State Governments of India. They are released when the government needs money, usually to fund infrastructure projects like roads, railways, or power supply systems.
• Municipal bonds: These bonds are issued by municipal corporations or related government bodies in India. The money raised through these bonds is used to fund public projects such as building bridges, schools, and hospitals, and improving basic services for households.
• Corporate Bonds: These are bonds that are issued by public or private companies. There are two types of corporate bonds: secured and unsecured Bonds. Secured bonds come with a temporary ownership of an asset of the issuer, similar to collateral. Unsecured bonds don’t come with any collateral. Collateral can be great should the company default on clearing the dues. Naturally, since this is a safer option, the interest rates are low and simultaneously, unsecured bonds have a high interest rate. 

Features of Bonds

Let’s look at some of the basic characteristics of a bond: 

Face Value: It is the principal value of the bond when issued by the company. When a bond matures, the company is liable to return this amount to the investor. 

Market Value: It is the value of the bond at a specific time. The market value of the bond may be different from its face value, subject to market fluctuations. 

Issue Price: It is the amount at which the company sells the bond. 

Coupon Rate: It is the rate of interest (on the face value) that is committed by the company to the investor as a return on investment. The coupon rate and the payment plan are defined by the company at the time of issuing the bond. 

Maturity Date: It is the date when the bond is set to mature. Every bond has to have a pre-defined maturity date. The company is supposed to return all the dues to the investor on or before the maturity date. 

Credit Quality: It is the ability of the company to return the dues to the investor within the committed timeline. There are credit rating agencies that assess the risk or the likelihood of the issuer returning the dues. They assign ratings to the issuers, thereby helping investors to evaluate their purchase. 

Advantages of Bonds

Here are some advantages of investing in bonds:

Fixed-Income Returns: This is one of the main attractions for investors who are looking at a long-term investment, along with regular income. The investor is entitled to a fixed ROI, depending on the type of bond. 

Protection of Capital: Unlike trading stocks and assets, bonds are less impacted by market fluctuations, thereby offering an excellent way to protect the investor’s money. 

Flexibility of Options: There are various types of bonds that serve different purposes. Additionally, investing in bonds is suited to both short-term and long-term. 

Predictable Returns: Owing to the key attributes of investing in bonds, the ROI is pre-defined and, up to a certain extent, guaranteed. 

Portfolio Diversification: Since investing in bonds is relatively less risky than stocks, it can help the investor’s portfolio by balancing out the overall risk. 

Trading Flexibility: Bonds can be traded on secondary markets, much like stocks. Additionally, investors can trade bonds with other investors before the maturity dates.

Limitations of Bonds

Here are some limitations of investing in bonds:

Interest Rate Fluctuation: When the interest rate of a bond increases, it undermines the value of the existing bonds that have a lower interest rate. Especially for long-term bonds, in such cases, the investor might wish to sell the bonds before maturity, which can result in losses. 

Inflation: As a common factor to most investment risks, inflation can lead to a decrease in the value of a bond if it outranks the interest rate. 

Credit Risk: The effectiveness of investing in bonds can only be positive if the credit quality of the company is good. If the company is ranked high on credit risk, there is a high chance of the company defaulting on payments. 

Liquidity: Sometimes, it can get difficult to trade or sell bonds quickly, which can create an issue for investors who wish to exit before the bond matures.

Limited appreciation: Bonds can help in increasing capital, but the potential for high appreciation is less. 

Investing in Bonds in India

In India, we see a lot of people investing in stocks and shares, but bonds are for those who are looking at more conservative and long-term investment options. 

In India, you can buy bonds from two marketplaces: The Primary and Secondary markets. In the primary market, you can purchase bonds directly from the issuing companies, and in the secondary market, you can purchase bonds from different investors.  

Here is how you can invest in bonds in India:  

Direct Investment: Investors can get help from professional brokers or firms that can execute the transactions, as they can connect the buyers with the lenders. Professional advisors can help connect your financial goals with your investment strategy. 

Bond Mutual Funds and ETFs: Here, you can invest in an entire portfolio of bonds from multiple issuers. 

RBI Retail Direct: It is a portal that was introduced by the RBI to help investors buy government bonds in the primary market and sell these bonds in the secondary market. It is convenient, safe and has an app version for people to download on their phones. 

Conclusion

Bonds can be a smart way to build a stable and diverse investment portfolio. They offer protection against market ups and downs and can provide steady returns over time. Before investing, always check the credit quality of the issuer and choose bonds that match your financial goals. With the right strategy, bonds can be a reliable option for long-term financial growth.

So, what are you waiting for? Start your investment journey with Torus Digital!