The bond market is also known as the debt market or a fixed-income market. It is a market where debt securities like government bonds and corporate bonds are traded. The bond market is generally less volatile than the share market.
Be it any kind of market, it has two categories of people, one who seeks money (companies, institutions) and the other who gives money (investors). In order to raise money, companies have got a handful of options, and bond finance is one such option.
This article contains all the information you might need to know about the bond market explained in the following subtopics.
Content:
- What are Bonds?
- How do Bonds Work?
- Types of Bonds in India
- Bonds vs Stocks
- Advantages of Bonds
- Disadvantages of Bonds
- Quick Summary
What are Bonds?
Bonds are fixed-income investments; they are considered a loan issued to companies, organizations, and national governments by people like you and me.
When you invest in bonds, you lend money(principal amount) to a company. Upon which, the company pays you a guaranteed income as the interest, and on maturity, the company pays back the principal amount as well.
In the following sections, find out how bonds work.
How do Bonds Work?
It is a simple give-and-take relationship. Governments and companies issue bonds to raise money. Investors buy those bonds for a fixed time period and, in return, get regular fixed interest payments.
The company repays the principal amount when the bond matures. But the investors or bondholders can resell these bonds before their maturity in the bond market since it is being resold and bought multiple times, and the bond price rises and falls until it matures.
To make you understand the working of bonds better, Let’s consider an example:
- Suppose a company wants to borrow ₹10 Lakh to buy machinery for its factory.
- The company decides to issue the bonds at a 10% interest rate for ten years of maturity time.
- Now, the company issues one thousand bonds at ₹1000 each.
- Each bond is going to receive ₹100 as interest every year for ten years.
- After ten years at the time of maturity, the original ₹1000 per bond will be returned, and the bond will be terminated.
You might be wondering about the different types of bonds in India. Well, don’t worry about it as the next section will explain the same.
Types of Bonds in India
Bonds can be classified roughly into four different types:
- Corporate Bonds
- Government Bonds
- Municipal Bonds
- Mortgage-Backed Bonds
Corporate Bonds
Corporate Bonds are the bonds issued by companies or organizations to expand their operations and businesses. These are long-term debt instruments and provide a maturity of at least one year.
Corporate Bonds are categorized as:
- Investment-grade bonds: It is a rating indicating that this is a high-quality bond and has a relatively low risk of defaulters.
- High-yield or Junk bonds: These bonds have a higher risk of defaulting than other bonds. Hence, the interest rates paid here are higher compared to investment-grade bonds.
Government Bonds
Government Bonds are the most attractive and safe bonds for traditional investors. These are national-issue bonds, often called sovereign bonds. Investors seek this bond because the government backs it, and the risk of default is very low because the government can cover the payments from the taxes collected from its citizens.
Government bonds certainly provide a sense of security for investors are they are government-backed. But this is not all, there are other government securities that you can check out and have knowledge about so that you may choose from the best options available.
Municipal Bonds
Municipal Bonds are generally tax-free bonds which makes them quite popular among investors who look for tax-saving options. These bonds are locally issued by states, cities, publicly owned airports, seaports, and other government-owned entities seeking to raise funds for various public utility projects.
Mortgage-Backed Bonds
Mortgage-backed bonds are a type of asset-backed securities. They are issued while keeping real estate properties as mortgages. An investor who buys these bonds is essentially lending money to home buyers or builders. The interest here is typically paid monthly, quarterly, or semi-annually.
As mentioned above, bonds and shares work differently. Please keep reading to find the difference between bonds and stocks.
Bonds vs Stocks
There are tons of differences between bonds and stocks. Both bonds and stocks are active and give liquidity. Some of the fundamental differences are:
- Bonds represent debt finances, while stocks represent equity financing.
- In bonds, the company is obliged to pay back the principal amount with fixed interest, while in stocks, the company carries no legal obligation to pay back to its investors.
- Bonds are less riskier as the returns are guaranteed. While stocks have a relatively higher risk than bonds, they have great potential for more significant returns and even more considerable losses.
While this was just a gist of how bonds and stocks are different from each other, we have a complete article dedicated to Bonds vs Stocks. Read it to differentiate better and choose which is a safer investment according to you!
Knowing everything about bonds and not knowing the advantages and disadvantages of bonds is not justified, so in the next section, you may find the pros and cons of investing in bonds.
Advantages of Bonds
Considering the suggestions of financial experts, you must diversify your investments, and there should be some allocations to bonds as well. Looking into the advantages of bonds, we have the following points:
- Less risky and volatile than stocks.
- Hugh options to choose from.
- Government and corporate bonds are the most liquid and active in the world.
- Bondholders are prioritized over the shareholder while making the repayments in case of bankruptcy.
Disadvantages of Bonds
Just like everything in this world, even bonds have both advantages and disadvantages.
You read about the advantages above, now let’s point out some of the disadvantages of investing in bonds.
- Since it is less risky, bonds come with a lower return on average.
- Buying bonds directly may be a difficult task for beginner investors.
- The risk of default shall also be taken into account.
- The return may get low if the interest rate lowers.
Although Bond Market is a safer space and offers a fixed return, the real game happens in the Stock Market, where shares of different companies are traded among the public. To understand how the stock market works. Read about Primary Market and Secondary Market here.
Quick Summary
- The bond market is also known as the debt market or a fixed-income market. It is a market where debt securities like government bonds and corporate bonds are traded. The bond market is generally less volatile than the share market.
- Bonds are fixed-income investments; they are considered as a loan issued to companies, organizations, and national governments by people like you and me.
- When you invest in bonds, you lend money(principal amount) to a company. Upon which, the company pays you a guaranteed income as the interest, and on maturity, the company pays back the principal amount as well.
- Bonds can be classified roughly into four different types:
- Corporate Bonds
- Government Bonds
- Municipal Bonds
- Mortgage-Backed Bonds
- Looking into the advantages of bonds, we have the following points:
- Less risky and volatile than stocks.
- Hugh options to choose from.
- Government and corporate bonds are the most liquid and active in the world.
- Bondholders are prioritized over the shareholder while making the repayments in case of bankruptcy.
- Disadvantages of investing in bonds
- Since it is less risky, bonds come with a lower return on average.
- Buying bonds directly may be a difficult task for beginner investors.
- The risk of default shall also be taken into account.
- The return may get low if the interest rate lowers.
We hope that you are clear about the topic. But there is more to learn and explore when it comes to the stock market, and hence we bring you the important topics and areas that you should know:
