Bonds

All You Need to Know About Bonds

Bonds Finance

People often tend to borrow money for some reason or another. It can be a bank loan or simply taking some money from a friend. But borrowing is not just confined to the common people; even the governments and large organizations borrow money to meet their expenses. These entities do so by issuing bonds. 

How do bonds work?

For large organizations wanting to raise money, bonds are a go-to option. Whenever an organization falls short on expenses, it searches for investors who can provide them with the capital. Since the amount is big, there are many investors on the list.

The organization, in return, promises to pay back the original amount invested by people along with added interest. For instance, you have purchased a five-year bond for Rs. 5000 with an interest rate of 3%. The organization, in return, will promise you to pay that interest on every specified period and eventually return your Rs. 5000 after five years. 

How to make money from bond investment

There are two ways in which investors usually make money from bonds: 

1. Investors hold the purchased bonds until it reaches the maturity period and avail the interest rates on them. The interest rate is paid as per the agreement. 

2. Another way to make earn profits is by selling the bonds at a higher price than the initial price paid.     

For instance, if you purchase bonds worth Rs. 2000 at face value and sell them when their market value rises to Rs. 3,000 you can earn a profit of Rs. 1,000.

Two reasons can lead to a hike in bond prices. If there is an improvement in the issuer’s credit risk profile and there is a better chance that it will repay the debt on maturity, the bond price increases. The value of a bond also increases when there is a decline in interest rates on newly issued bonds.

Investment in bond funds

Money taken from several investors is collected by a Bond Fund, and a fund manager is asked to manage it. The latter then purchase a range of bonds using that money. Investment in a bond fund involves even less risk than investing in individual bonds.

Kinds of bonds

There is a wide range of bonds in the market, and each one has its unique advantages and drawbacks.

1. Government Bonds:  The state and central government in India issue these bonds.

2. Corporate Bonds: Private companies issue these bonds. They borrow money from investors for a certain period of time and give them a fixed interest rate till its maturity.

3. Zero-Coupon Bonds: They are also called pure discount bonds, and they do not yield a regular interest till their maturity. 

4. Convertible Bonds: These bonds are known for providing the benefits of both debt and equity. But investors cannot avail of both these benefits simultaneously.

5. Inflation-Linked Bonds: This kind of bond protects investors from inflation and is issued in order to completely do away with the inflation risk of an investment.

This bond provides tax exemption to the investor. It is one of the most preferred bonds by investors because, as it is offered by the government, it is considered highly secure. If investors want to redeem their investment in this bond, they can do so only after five years.

Why bond investment is beneficial

1. Safe Investment – Purchasing bonds are a safe investment compared to stocks. The prices of bonds don’t fluctuate as rapidly as the prices of stock.

2. Income  Bonds ensure stable income, as you can expect a fixed amount of interest every six months.

3. Community  By investing in a municipal bond, you can contribute to a social welfare project such as the development of a public park or school while also ensuring a regular income.

4. Diversification  If you invest in bonds, you are actually wisely spreading your investment and reducing your risk. It is always sensible to have both stocks as well as bonds in your investment portfolio.

Is investing in bonds really that good?

That entirely depends on what kind of investor you are and what you expect from your investment.

If you hate the very thought of losing money, you would be better off investing in bonds.

If you have already put in a lot of your money in stocks, you can reduce the risk by diversifying and buying bonds.

If you are a senior citizen, it would be wiser to invest in bonds instead of the highly volatile stock market. Actually, with advancing age, it is advisable to gradually diversify your investment into bonds. Of course, there is no need to off-load all your stocks when you retire.

Conclusion

Bonds offer several advantages that other investment options cannot offer. So if you are looking to invest your money, it is best that you opt for investing in bonds.  

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