Table of Contents
What are Fixed Income Instruments?
Bond Market Investments – What are the Pros and Cons?
How much do you know about the Bond markets? In simple terms, it is a marketplace for debt securities. While the government issues debt instruments, this market is also covered by various private companies.
Bond markets let capital transfer happen from savers. There is transfer of capital to issuers and investors who need finances for their projects. The terms credit, debt or fixed-income are generally used to describe these markets. Read on and get an idea about what a bond is, the different types of bonds that are in existence, primary and secondary bond markets, the way bonds are traded in all bond markets etc.
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What are Fixed Income Instruments?
These actually refer to investments in which your principal is regarded to be comparatively safe, i.e., safer than equity.
Interest is paid by the borrower either annually, semi-annually or quarterly. There is return of capital to the investor when it matures. Fixed deposits, for instance, are bonds the issued by corporate entities, government-related agencies and the government.
Also read: How Has the Indian Stock Market Performed in the Last 10 Years?
What is a Bond?
This is actually a fixed-income instrument. It symbolizes a loan given to a borrower – generally a government or corporate entity – by an investor.
A Bond could be regarded as an “I owe you” document which acknowledges a debt. This comprises of the loan details and the payments for the same.
Bonds are generally used by sovereign governments, states, municipalities and companies for funding operations and projects. People in ownership of bonds are creditors or debtholders of the issuer.
What are Bond markets?
Also often called the debt market, this is a credit market or fixed-income market. In the bond markets, publicly-traded companies or the government issues bonds – for funding ongoing business operations or projects for business expansion.
How Bonds are traded?
Unlike stocks, the trading of bonds happens over the counter through dealers or brokers. These have a wide range of credit ratings, coupons and maturities – which make them more complicated than the stock market. In the stock market, most of the companies generally have only one stock class on offer for the public.
The pricing of bonds is mainly done as per to important factors:
- The creditworthiness of the borrows, and
- Interest rates.
There can be a drop in bond prices, particularly in case of corporate bonds, if there is a concern among investors about the insolvency of the borrower in the future.
What are the Different Types of Bonds?
Bond markets can be categorized in different ways:
On the basis of transactions
It is possible to purchase or sell bonds in two distinct methods. It can be done either via primary market or via secondary market.
Primary Market
This type of market refers to all those bond markets in which there are new issues of bonds. In case you plan to purchase a bond from primary market, you have to purchase it directly from the seller. It could be a bank, a company or some other financial entity.
Secondary Market
These types of bond markets are involved in the sale and purchase of bonds between investors, with a broker serving as the medium. These bonds, in a way, are traded in the form of stocks from one investor to another instead of a borrower company.
The volatility of bonds is generally less as compared to stocks. This is due to the fact that bond prices and yields might fluctuate over a period while maturities and coupons do not.
On the basis of issuer
In this manner, the sale or purchase of bonds can happen in two ways:
Corporate Bond markets
The corporate bond markets are comprised of both privately held and publicly credit companies. Debt securities or bonds are sold by them to fund capital projects.
Corporate bonds, in comparison to other forms of bonds, provide investors with higher yields.
However, there may be a wide variation in yields from one company to another. It is actually based on their business prospects and credit ratings.
Bonds are categorized into grades of investment such as AAA, BBB etc. Bonds that come with a lower rating are referred to as ‘high-yield bonds’ or ‘junk bonds’, given the fact that investors can be paid a higher coupon rate. However, the default risk is much higher in this case.
Government Bond markets
Bonds are also issued by the government for borrowing funds from the public. When you purchase Government bonds, periodic interest payments are made to you according to a prefixed coupon rate. You will be able to redeem the principal amount, which is also referred to as the bond’s “face value”, when it matures.
Bonds are issued by the reserve Bank of India on behalf of the Government of India, which is also referred to as G-Secs. G-Secs having a matured period of less than 1 year are referred to as treasury bills. Government bonds are those having longer period of maturity.
These are practically referred to as risk-free. You can make investments in Government bonds via the retail direct portal of RBI, banks, mutual funds, stock brokers etc.
These are some of the common types of government bonds in bond markets:
- Floating rate bonds
- Fixed-rate bonds
- Zero-coupon bonds
- Sovereign gold bonds
- Inflation-indexed bonds
- Municipal Bonds
- State development loans
- Cash management bills
- Treasury bills
Bonds are issued by municipal corporations, municipal committees and other Urban Local Bodies (ULBs) in order to carry out fundraising for different infrastructure development projects. When you purchase such bonds, you actually lend money to the local body in charge of issuing such municipal local bonds.
This money is then used by urban local bodies for the development of infrastructure projects in the region concerned. Investors get their principle amount along with interest, according to the rate of interest that was determined while issuing bonds.
Municipal bonds involve low amount of risk and are regarded as transparent. Regulatory authorities govern these types of bonds. But it must be understood that these have lower interest rates, liquidity constraints and longer lock-in period than other debt instruments.
Bond Market Investments – What are the Pros and Cons?
There are quite a few advantages and disadvantages of making investments in the bond markets:
Pros
- It is possible for investors to gain a reliable income stream.
- Typically, bonds are regarded as low-risk investment options as compared to stocks.
- It is possible to get a fixed rate of return with bonds, which make them a more predictable option for investment.
- Bonds help in portfolio diversification for investors, which can be useful for overall risk reduction.
- Credit ratings allow investors to pick the best option aligning with their risk tolerance.
Also read: Volume in Stock Market – Top Things Investors Should Know About.
Cons
- Investors get lower returns from bonds than stocks. The returns obtained from bonds can easily be reduced due to inflation and the actual returns can effectively get lower because of this reason.
- The issuer can always default, and this risk is perpetual; particularly for lower-rated bonds.
- The liquidity of some bonds may be lower than that of others, which can make it tough to get buyers for them in the secondary market.
- Political events, economic indicators and other market conditions can have an impact on the value of bonds.
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Conclusion
When it comes to debt securities, the bond markets happen to be a safe marketplace. These help in the transfer of capital to issuers from investors and helps with funding projects. Bonds are mainly priced on the basis of two important factors, borrowers’ creditworthiness and interest rates. These can be traded through exchanges as well as through dealers or brokers over the counter.
