Bonds are debt instruments that are issued by companies, municipalities and governments to raise funds for financing their capital expenditure. By purchasing a bond. an investor loans money for a fixed period of time at a predetermined interest rate. While the interest is paid to the bond holder at regular intervals, the principal amount is repaid at a later date, known as the maturity date. While both bonds and stocks are securities , the principal difference between the two is that bond holders are lenders, while stockholders are the owners of the organization.
Types of Bonds
The main types of bonds are:
Government Bonds
These are fixed income debt securities issued by the government. Government bonds are further categorized on the basis of the term (maturity duration).
- Government Bills :- These are government bonds with a maturity period of less than one year.
- Government Notes :- These are government bonds with a maturity period from one year to ten years.
- Government Bonds :- These are government bonds with a maturity period that exceeds ten years.
Corporate Bonds
These are debt instruments issued by a company and backed by its ability to generate profits or by the current value of its physical assets.
Long term Infrastructure Bonds
In 2010, the government introduced a new section 80CCF under the Income Tax Act, 1961 to provide income tax deductions for subscription to long-term infrastructure bonds. Subsequently, the Central Board of Direct Taxes passed a Notification No. 48/2010/F.No.149/84/2010-SO(TPL) dated July 9, 2010.These long term infrastructure bonds offer an additional window of tax deduction on investments up to Rs. 20,000 for the financial year 2010-11. This deduction is over and above the Rs. 1 lakh deduction available under sections 80C, 80CCC and 80CCD read with section 80CCE of the Income Tax Act. Infrastructure bonds help in intermediating the retail investor's savings into infrastructure sector directly.
How Bonds Trade
Bond trading is usually done through bond dealers and can take place anywhere where a buyer and seller strike a deal. Unlike for equities. there is no exchange for bond trading. which mostly takes place in an 'over-the-counter market. The exceptions for this are certain corporate bonds particularly in the US, that are listed on an exchange. Moreover, derivatives, such as bond futures and certain bond options, are traded on exchanges.
Bond Price Variations
A bond's price refers to the amount investors are willing to pay for an existing bond. The bond's price is important if you wish to trade the bond with another investor.
Interest rate
When interest rates in the market rise, newly issued bonds become more lucrative (offer higher yields). This makes existing bonds less competitive and exerts pressure on the price of existing bonds. Thus interest rates and bond pricesmove in opposite directions.
Inflation
High inflation erodes the value of the return that is earned when the bond matures. Thus inflation and bond prices also move in opposite directions.
Financial health of the issuer
The financial health of the company or government that has issued the bond impacts bond prices. If the issuer is financially healthy, investors have greater confidence in receiving the interest payments and principal 0000e0 00 maturity. Investors typically stay in touch with