Bonds - Definitions, Functions & Classifications

Bonds

Bonds is a debt instrument which is issued through the corporation, government and other organisation for raising capital and purchased by the investors. It is a loan agreement between the bond issuer and an investor. On the other hand, bonds and other fixed-income securities play a critical role in an investor's portfolio. Owning bonds helps to diversify a portfolio, as the bond market doesn't rise or fall alongside the stock market. More important, bonds are generally less volatile than stocks, and are usually viewed as a "safer" investment.

How does it WORK ?

When an investor purchased a bond by the issuer, he actually lending them fund for raise their capital. Bond has a fixed maturity date. After maturity of the bond, bond issuer has to repay the principal amount to investor. In most cases, the investor will receive regular interest payments from the issuer until the bond matures. Eg. When a company needs funds, they may issue a bond to finance that loan. Much like a home mortgage, they ask for a certain amount of money for a fixed period of time. When that time is up, the company repays the bond in full. During that time the company pays the investor a set amount of interest, called the coupon, on set dates, often quarterly.

Types of BONDS

Central Government bonds

These bonds are issued by the RBI on behalf of the Government. The primary purpose of these bonds is to finance fiscal deficit and meet the shortfall of revenue in the Government budget.

State Government bonds

These bonds are listed on Stock exchange and issued by the State Government to meet their fiscal deficit.

Municipal and Local authority bonds

These bonds are issued for raising fund to meet specific goal such as construction, road, highways, etc. These bonds are rated by credit rating agencies and it is best to go by the rating and past records before investing.

Corporate bonds

These bonds are issued by company and sold to investors. In general, corporate bonds are considered to have a higher risk than U.S. government bonds. As a result, interest rates are almost always higher on corporate bonds, even for companies with top-flight credit quality.

Public Sector bonds

These bonds are issued by highly rated public sector companies for meeting their growth and expansion needs. These bonds are relatively less risky since PSUs are under the Government. Generally, these bonds are issued by companies where the Central Government is the majority shareholder.

Tax free bonds

In this type of bonds, interest received is fully exempted from tax under Section 10. However, the principal amount invested in these bonds cannot be claimed as a deduction from the total income of the bondholder for the purpose of payment of income tax. Companies such as the National Highways Association of India (NHAI), Indian Railways Finance Corporation, HUDCO, Rural Electrification Corporation (REC) issue these bonds. The interest earned on these bonds is completely tax free in the hands of the investor.

Note : Investment in securities market / Mutual Funds are subject to market risks, read all the related documents carefully before investing.