When investors give a loan to large organizations such as National Governments, cities, and corporations, they get bonds in return.
A single bond is only a minuscule part of a huge loan. Since the above mentioned entities are large in size, they require numerous sources to fill up their expense list. Due to the stability that they provide, bonds are considered fixed-income investments and are classified as broad assets.
What are the types of Bonds?
Bond investments are of various types; this variation is a result of their length, interest rate, risk, and the body issuing them. Types of bonds one can invest in India:
- Government Security Bonds: These bonds are issued by the state and central government in India.
- Corporate Bonds: These bonds are issued by the companies. Investors lend their money to the companies for a specific period of time, and the companies give the investors a fixed interest rate throughout the tenure.
- Zero-Coupon Bonds: This bond is also known as pure discount bonds. Unlike other types of bonds, investors cannot avail regular interest rate in this case till the bonds get mature.
- Convertible Bonds: This type of bond offers features of both debt and equity, however not at the same time.
- Inflation-Linked Bonds: As the name suggests, this type of bond provides protection against inflation and is issued for eliminating an investment’s inflation risk.
- RBI Bonds: RBI, India’s central bank and regulatory body issues floating rates savings bonds (FRBS), also called the RBI taxable bonds, for a period of seven years. The interest rates keep floating during the tenure.
- Sovereign Gold Bonds: The central government of India issues this type of bond for people who would like to invest in gold but don’t want to keep gold as a physical asset with them.
How do Bonds really work?
The organization that borrows money from investors promises to pay that money back on an already agreed date. Till the maturity period is achieved, the organization or the borrower provides specific interest payments to the investor. These investors who are the actual owners of the bonds are also referred to as bondholders or creditors. In the olden days, the whole process was carried out on paper, but now with the advent of technology, it is all done on digital platforms.
The borrowers repay the investor upon reaching the maturity period. However, there are instances where investors can resell the bonds before the maturity period. This can be done because there is also a secondary market for bonds.
For those who don’t know, bonds can be traded in two ways: either publicly on exchanges or between the broker and the creditor.
A bond’s value can fluctuate due to this resell feature.
What Bonds Say About the Economy
Bond investments are one of the most stable investment options in the market. Their stability can be seen when there’s a decline in the stock market and economy in general. The best part about investing in bonds is that they are not much impacted by market volatility.
Bonds and the Stock Market
Investors don’t really pay attention to bonds when the stock market is doing well. Due to this reason, their prices drop. In this scenario, organizations have no option but to give high-interest rates to make the investors buy those bonds.
When there’s a decline in the economy, investors opt to purchase bonds even if the interest rates are low so that they can keep their money safe. In this scenario, the borrower can take a sigh of relief as he doesn’t have to pay high-interest rates to the investor.
Bonds and Interest Rates
The economy of any nation can be impacted by the interest rates of bonds. Investors who are willing to put their money in this area search for all the various types of bonds before they invest in bonds. They usually prefer bonds with lower risk and high-interest rates.
Bonds with lower interest rates are often ignored as it results in lower costs of items one can purchase on credit. These commonly include loans for education, automobile, or business. Mortgage interest rates are also impacted by the bond value.
An investor lends his/her money to a borrower or an organization in need of money. The organization that issues these bonds is called the “debtor” or, in simple words, the borrower. A person who invests in bonds is known as the “creditor” or simply lender.
Upon reaching the maturity period, the borrower pays the money back to the investor, known in the financial world as the “principal.” Apart from this, the borrower also has to pay fixed interest rates to the investor as agreed. This is how the investor makes real profits by investing in bonds. The advantage of purchasing bonds over stocks is that they are less risky in nature. But make sure that before investing in bonds you read all the market reviews.