What is Bond and How to Invest in the Bond Market?

Whenever it comes to bonds, the first thing that comes to our mind is that what are these bonds, how do bonds work and how will you be able to invest in them.

What is a bond and how do bonds work?

Bonds are a way for the government and companies to borrow money. Government and companies have 2 main ways to borrow money.

Bank Loans
Bonds

Now the question comes that if the bank is ready to give a loan, then why do the government and companies sometimes borrow money through bonds.

There are 2 main reasons behind this:

Generally banks charge more interest rates than a bond.
When companies have to raise a very large amount, then it is easy for them to raise a large amount through bonds at such times.

Types of Bond

There are mainly 2 types of bonds:

Government Bonds
Corporate Bonds

Government Bonds Explained

Government bonds are those bonds that the government issues. Government bonds are considered the safest investment, even more than Fixed deposits (FD).

Whenever you withdraw a fixed deposit, you get insurance up to Rs 5 lakh on it, that is your amount up to Rs 5 lakh in FD is absolutely safe.

But as far as government bonds are concerned, whatever your total investment here is completely safe. Because the government has given you a guarantee for that.

When you lend money to the government through government bonds, you have to get 100% of your money.

Corporate Bonds Explained

Corporate Bonds are the bonds that companies issue. Generally, corporate bonds pay more interest than government bonds. The main reason for this is that they are also a bit risky.

Because as we have seen that the government will return your money 100%, but there is no guarantee of companies.

Corporate bonds involve risk, so 2 things are seen here:

Financial: What is the financial condition of the company which is borrowing money through bonds and how strong is that company financially.

For example: If we talk about TATA Group, HDFC Group then these are very strong groups where the risk will be very less. Because their financially backup is very good.

Credit Rating: Whenever the government or company issues a bond, it is compulsory to take a credit rating for it and they take this rating from the credit rating agency.

Symbols of Government Bonds

The symbol of Government Bonds is generally like this 832 GS 2032. Here GS means Government Security. 832 means that that government bond will pay you 8.32% interest annually.

Generally, Bonds pay interest 2 times in a year. Meaning the bond that pays 8.32% annually will pay 4.16% and 4.16% interest 2 times in such a year, which will total 8.32%.

2032 means that there is the maturity of that bond in the year 2032, i.e. till the year 2032, you will continue to get 8.32% interest every year.

And then whatever amount you had invested in the bond, you will get it back in the year 2032.

Example second: 915 GS 2024 This means that this is a government bond, it will pay an interest of 9.15% annually.

And then whatever amount you have invested in this bond will get the return in the year 2024.

Government Bonds	Annual Interest Rate	GS means	Maturity Year
832 GS 2032	8.32%	Government Security	2032
915 GS 2024	9.15%	Government Security	2024

How governments and companies raise money from bonds

Here we will understand the bonds completely by taking the example of NHAI (National Highway Authority of India).

The job of NHAI (National Highway Authority of India) is to build highways. When the construction of the highway is going on, you must have seen the boards of NHAI many times near the road.

So to build Highways, the first requirement of NHAI is funded (capital).

So in such a situation, NHAI borrows money from Bonds to build the highway. In bonds, companies and governments borrow directly from public and financial institutions instead of banks.

Read Also: Stock Market Timings in India

Here companies and governments generally offer more interest than the bank rate to the public through bonds.

As recently, Reliance Jio raised money through the bond, and in this bond, they have given an interest of 8.32% to the investors.

Now the interest rate of 8.32% is more than the interest rate of the bank as of now. So in such a situation, the public got the opportunity to earn a better return.

What is Bond and How to Invest in the Bond Market?

The same interest rate offered by Reliance Jio is less than the bank loan. Because Reliance Jio would have taken money from the bank, then Reliance Jio would have had to pay more than 10% interest rate comfortably.

So here the bonds have created a win-win situation for both investors and companies.

Companies and government have to pay less interest than a bank loan and the same public are getting better returns from FD & Savings account.

So NHAI decided that to build highways, raise money from bonds itself, and with the help of money borrowed from bonds, NHAI started building highways.

After the construction of the highway, NHAI imposes a toll plaza or gives a contract of toll plaza to someone and then collects toll from whatever vehicle will go through that highway.

And then with that money, the people of NHAI who had bought the bonds, return their money.

As far as bonds are concerned, it is very important for you to understand 2 things there:

Coupon Rate
Maturity

The credit rating of bonds is like this

Standard & Poor’s	Grade	Risk
AAA	Investment	Lowest Risk
AA	Investment	Low Risk
A	Investment	Low Risk
BBB	Investment	Medium Risk
BB, B	Junk	High Risk
CCC/CC/C	Junk	Highest Risk
D	Junk	In Default

AAA means that the risk is very low and that the bond is very safe.

AA means that the risk is still low.

A means that the risk is low.

BBB means that medium risk is in this bond.

BB, B means that the risk is high.

CCC/CC/C means that the risk is very high.

D means that the bond is in default i.e. that the company is not able to pay interest to its bondholders.

You should pay attention to the financial condition of the company and its financial backup more than credit rating. Like TATA Group, HDFC Group, Infosys, Reliance Industries, all these companies are such that their financial position is very strong.

Due to which the bonds of these companies are less at risk because in the past it has happened many times that even after giving AAA ratings by the credit rating agency, those bonds have defaulted.

2008 Financial Crisis

In the financial crisis of 2008, there was a loss to the investors in many companies who had invested after seeing the rating of AAA.

IL&FS is a very big group in India and all the bonds of this group were given an AAA rating by the credit rating agency of India. And then in June 2018, IL&FS Transportation Network, a company of IL&FS, defaulted.

But despite that, the rating of the rest of the bonds of IL&FS remained AAA.

So in such a situation, many bondholders who were only following the credit rating did not see the risk there and then in July-August 2018, the rest of the bonds of IL&FS also started defaulting.

And after that default public, the credit rating agency changed its rating. Because of his mistake, SEBI imposed a fine of 25 lakhs on all three credit rating agencies ICRA, Care Ratings, India Rating & Research.

Which was further increased to 1 crore.

Any company which has to issue a bond has to go to the credit rating agency and get it’s bond a credit rating. And its fee has to be paid to that credit rating to that company.

So here a conflict of interest is prepared. Because money is also to be taken from the client and the product of that client has to be given rating.

So always keep this conflict of interest in mind.

What are Junk Bonds

There are also some companies that are in bad condition and if such companies issue bonds of poor quality then it is called JUNK Bonds. There is a lot of risk in these bonds.

And then Junk bonds also pay a lot of interest to attract investors. In the case of junk bonds, you don’t just have to look at the interest rate, you have to understand that there is a lot of risks there.

How to Invest in Bonds?

There are 4 main ways to invest in bonds:

Demat Account
ETF (Exchange Traded Fund)
Debt Mutual Fund
Corporate Bonds Fund

Demat Account

You can directly invest in bonds through the Demat account. For that simply, wherever you have opened your Demat account, you have to go to that app and select that bond.

And then simply from that, you will be able to invest in bonds. Many brokerage firms do not provide the facility of a bond investment.

Sometimes the bonds investment facility of brokerage firms is a bit complex.

ETF (Exchange Traded Fund)

You can invest in bonds through many ETFs (Exchange Traded Funds) such as Edelweiss Bharat Bond ETF, SBI 10 year Gilt ETF, Nippon India Long Term Gilt ETF, etc.

Another important thing is that recently RBI (Reserve Bank of India) has announced that soon they are coming up with a bond investment platform for retail investors.

Due to which you will be able to invest directly in bonds without any brokerage firm. In this year’s budget, the government has announced that they are going to borrow a lot of funds.

This retail bond investment platform of RBI can also help the government to raise funds. Actually, RBI had done this type of effort even before this but nothing special execution could be done in it.

Debt Mutual Fund

If you do not have much understanding of the market, then a very simple way to invest in bonds is Debt Mutual Fund.

You will be able to invest in bonds through Debt Mutual Fund. If you want that you have to invest only in Government bonds, then for that you will have to invest in Gilt Fund.

Almost every Mutual Fund company has Gilt funds such as SBI Magnum Gilt Fund, Axis Gilt Fund, etc.

Corporate Bonds Fund

If you want to invest in Corporate Bonds, then you can invest in Corporate Bonds Fund for that. If you want to invest in bonds for the short term then you can invest in Short Term Debt Fund.

You can easily invest in Debt Mutual Fund through any mutual fund app or by directly visiting the website of that asset management company. And you can also start your SIP there.

If you are planning to invest directly in government bonds, then you can invest directly in government bonds from 10 thousand rupees. If you are planning to invest indirectly in bonds through mutual funds, then you can do that.

if you are planning to earn a little more return then you can invest in such corporate bonds.

Whatever names we have mentioned here, it does not mean that you should invest in the bonds of these companies, it was just to give you an example, that you should invest in the bond of a financially strong company.

Advantage of Bonds

The biggest advantage of bonds is that you get a lot of flexibility here. You can also go to absolutely safe bonds such as government bonds, as well as you get options for corporate bonds and other bonds.

It is also very easy to invest in them.

This whole process is very transparent and also you get tax benefits in many bonds.

Disadvantage/Risk of Bonds

Bonds generally have 3 types of risk:

Credit Risk
Price Risk
Liquidity Risk

Credit Risk

Credit risk means that the government or company will be able to return you time to time interest and money borrowed from you or not.

As far as government bonds are concerned, there is no credit risk. Company to company credit risk varies in corporate bonds.

Price Risk

Bonds get listed on the stock exchange after the issue and then if you have a chance to sell the bonds before maturity, then you will have to find a buyer on the stock exchange there.

Sometimes that buyer can also give you a lower price. So if you are not able to hold the bonds till maturity then you may have to face the price risk.

But if you are holding that bond till maturity, then there is no question of price risk.

The price risk is only for those people who want to exit the bonds in the middle, then invest the same money in the bonds which you do not need till maturity of that bond.

Liquidity Risk

Liquidity risk is also there for those investors who want to exit the bonds before maturity. After the issue of bonds, the bonds get listed on the stock exchange. But many times you may not get the buyer while selling the bond, it is called liquidity risk.

Liquidity risk is also for those investors who want to sell that bond before maturity. So before investing in a bond, understand these three risks very well.

What is a bond and how do bonds work?

Bonds are a way for the government and companies to borrow money. Government and companies have 2 main ways to borrow money.
1. Bank Loans
2. Bonds
Now the question comes that if the bank is ready to give a loan, then why do the government and companies sometimes borrow money through bonds.

What are Junk Bonds?

There are also some companies that are in bad condition and if such companies issue bonds of poor quality then it is called JUNK Bonds. There is a lot of risk in these bonds. And then Junk bonds also pay a lot of interest to attract investors. In the case of junk bonds, you don’t just have to look at the interest rate, you have to understand that there is a lot of risks there.

How to Invest in Bonds?

There are 4 main ways to invest in bonds:
1. Demat Account
2. ETF (Exchange Traded Fund)
3. Debt Mutual Fund
4. Corporate Bonds Fund

What is Liquidity risk?