What Is a Bond?

A bond has a face value, the amount borrowed, a coupon, the interest paid regularly, and a maturity date, when the face value is repaid. For example, a borrower might issue a bond with a face value of Rs 1,000, pay interest twice a year, and repay the Rs 1,000 after five years. These numbers are only an illustration.

Central government: government securities and treasury bills.

State governments: state development loans.

Banks and public sector companies: bonds and certificates of deposit.

Private companies: corporate bonds and commercial paper.

Governments borrow to fund roads, schools and other spending. Companies borrow to build factories, expand or manage cash flow. Issuing bonds lets them borrow from many investors at once instead of only from banks.

Bonds can be bought and sold before maturity, and their prices change. When interest rates rise, new bonds pay more, so older bonds with lower coupons become less attractive and their prices fall. When rates fall, older bonds with higher coupons become more valuable and their prices rise.

Our page on repo rate explains how interest rate decisions are made.

The yield is the return you get on a bond based on its current price, not just its coupon. If a bond price falls, its yield rises, and the other way round. Yield to maturity estimates the return if you hold the bond until it matures and all payments are made.

Our page on YTM and modified duration explains these terms.

Longer-term bonds are more sensitive to interest rate changes than short-term ones. Duration measures this sensitivity. A bond with high duration can swing a lot in price when rates move.

The biggest risk with company bonds is that the borrower fails to pay interest or repay the principal. Credit ratings like AAA or AA help judge this risk. Government bonds carry practically no default risk.

Our page on credit ratings in debt funds explains the rating scale.

Some bonds trade rarely, so selling them before maturity can be hard or may mean accepting a lower price. Government bonds usually trade more easily than smaller company bonds.

A fixed deposit is like a loan to a bank with a set rate and no price changes if held to maturity. A bond can be traded and its price can move, and its safety depends on the issuer.

Our page on mutual funds versus bonds compares holding bonds directly with funds.

A share makes you a part-owner of a company, with no promised payments but potential for growth. A bond makes you a lender, with set interest payments but limited upside. Bonds are usually steadier; shares usually grow more over long periods.

Our page on equity versus debt funds explains the difference for funds.

Debt mutual funds: the simplest route, with diversification and professional management.

Government platforms: the RBI offers a platform for individuals to buy government securities directly.

Online bond platforms: SEBI-registered platforms offer listed corporate bonds, often in smaller amounts than before.

A debt fund holds many bonds, spreading credit risk, and lets you invest small amounts and redeem easily. You can choose funds by time frame and credit quality.

Our pages on debt funds and how to choose a debt fund explain how.

Gilt funds invest mainly in government securities, so they carry very little default risk but can swing with interest rates. Target maturity funds hold bonds maturing around a set date.

Our pages on gilt funds and target maturity funds explain both.

Bonds and debt funds bring stability. When shares fall, high-quality bonds often hold steady, softening the overall swings. They also suit money needed in the next few years.

Our page on asset allocation explains how to balance them with equity.

Bonds offering unusually high interest usually carry higher risk of default. Before buying any individual bond, understand who the borrower is and what could go wrong. Do not judge only by the interest offered.

Suppose you hold a bond paying a certain interest each year. Then interest rates in the economy rise, and new bonds start paying more. Nobody would pay full price for your older, lower-paying bond, so its market price falls until its yield roughly matches the new bonds. If rates fall instead, your bond becomes more attractive and its price rises. If you hold to maturity and the borrower pays, you still get the face value back. These are general ideas, not forecasts.

• Who is the borrower, and what is their credit rating?
• When does it mature, and can I hold it that long?
• How easily can I sell it before maturity?
• How is the interest taxed for me?

Interest from bonds is generally taxed as income, and gains on selling bonds or debt funds follow their own rules. We do not quote tax rates. A tax adviser can help.

• A bond is a loan that pays interest.
• Prices move opposite to interest rates.
• Risks: default, rate changes, liquidity.
• Debt funds are the easiest way for most people.

We are distributors rather than investment advisers and we recommend no schemes. If you want help adding steady debt investments to your plan, get in touch.