Common Financial Terms & Concepts

What are Bonds?

What are Bonds?

Bonds are a type of Debt instrument that allows companies and governments to borrow money from the common public and Institutions. When these institutions issue securities they are generally called debt securities or Bonds. The issuer of the Bond has a moral obligation to pay back the sum to the holder of the Bond.

Bonds are governed by a legal contract that exists between the Issuer of the Bond and the Holder of the Bond. This contract is also known as the “Bond Indenture”. In any case, if the issuer of the Bond does not pay the holder the promised sum as per the Bond contract then the Bondholder has a Legal authority to get the Sum assured from the Bondholder.

Bond - Main 3 Aspects to Know

  • Par-Value
  • Maturity date
  • Coupon rate

1. Par value

The “par value” of a Bond describes the Principal or the par value (amount) that will be paid by the issuer of the bond to the bondholder on the maturity of the bond. The par value of a bond is also used to see at what price a bond is being issued. Generally, Bonds are issued either at a Discount or a Premium to the Par value.

This means that, if the Par value of a bond is Rs 1000, then it can be issued at a discount of 10% which is Rs900 or it can be issued at a premium of 10% which will be at Rs 1100. In this way, the price of a Bond is judged in respect of its par value.

2. Maturity date

The maturity date of a bond is the date on which the Bond issuer is supposed to return the principal amount to the Bondholder with or without the interest accrued till that period. The maturity of a Bond differs from institution to institution and issuer to issuer according to their needs. The maturity can be of a Short duration, For example, 7-60 days or Long 10 - 30 years depending on the Issuer. The maturity date is also the date till which the bondholder will receive interest from the issuer.

3. Coupon Rate

The Coupon rate is another term for the Interest Rate which the Bond Issuer promises to the bondholder. The coupon rate is always applicable on the “par value” or the principal value of the bond. For example, if the par value of a Bond is Rs 1000 issued at a premium of 12%, having a coupon rate of 6%, then the amount of interest that is to be calculated has to be always on the par value which is Rs 1000, in this case, and not the Issue price which is Rs1120.

Conclusion-

Bonds are a kind of Debt instrument that provides a steady source of income to the Bondholder in the form of Interest. Bonds are considered to be less risky than other asset classes like Equity as the chances of Default are very less as the Issuer of the Bond is obliged by law to pay back the principal amount and the interest to the Bond Holder.

Ask your questions here

YTM or yield to maturity is an effective way to find out the exact return that a bond offers when held till maturity. The YTM of bonds changes with the change in the purchase price of the bond. Even if a bond has a fixed coupon rate payable on the face value, the effective yield depends on at what price one purchases it.

Government securities include both T-Bills (Treasury Bills) and Government bonds which are both short and long-term instruments issued by the Central & State governments for various purposes. Retail investors are allowed to invest in G-Secs provided by the RBI. One can buy them directly from the Stock exchanges in a non-competitive method.