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Bonds

Reviewed by Annapoorna | Updated on Oct 05, 2020

Catalogue

Introduction

Bond is a financial instrument issued for a loan offered by an investor to a borrower being the Government or Corporate entity. It bears a fixed repayment that is paid on the maturity or expiry of the due date to the investor.

Understanding Bonds

A bond can be of two types -Municipal and Corporate Bonds. When a company issues a bond, it is divided into units of corporate debt. It can generate a fixed income on a later date.

When companies need money to fund new projects or maintain ongoing business or refinance existing debts, they can issue bonds to investors. The borrower (issuer) will define the terms of the bond, interest or coupon payment intervals and maturity date by when the principal must be paid back to the investor (lender).

Factors to consider before you invest

  1. Bonds are available as mutual funds too. Bond funds can help earn a regular and secure income.
  2. Zero-coupon bonds are another popular type of bonds that are bought at a deep discount on the face value. In return, payments are not made at regular intervals, but the principal and the interest will be paid out together on the maturity date.
  3. The quality of the bond is a paramount factor while choosing to invest. It refers to the chance that the bondholders will receive the amounts promised at the due dates.
  4. The yield is referred to the rate of return received by the investor on the maturity of the bond. There are two methods of calculating yield. One is the current yield (annual interest payment divided by the market price). The other is the yield to maturity (YTM) which is a more realistic measure for bonds. It is calculated as follows: [(face value/present value)1/Time period]-1. YTM is compared with the coupon rate(Interest rate of the bond) for investors to decide whether or not to proceed with the investment.

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