Bonds And Debentures In India

A Bond is a loan given by the buyer to the issuer of the instrument. Bonds can be issued by companies, financial institutions, or even the government. Over and above the scheduled interest payments as and when applicable, the holder of a bond is entitled to receive the par value of the instrument at the specified maturity date.

Bonds can be broadly classified into

1. Tax-Saving Bonds

2. Regular Income Bonds

Tax-Saving Bonds offer tax exemption up to a specified amount of investment. Examples are:

1. ICICI Infrastructure Bonds under Section 88 of the Income Tax Act, 1961

2. NABARD/ NHAI/REC Bonds under Section 54EC of the Income Tax Act, 1961

3. RBI Tax Relief Bonds

Regular-Income Bonds, as the name suggests, are meant to provide a stable source of income at regular, pre-determined intervals. Examples are:

1. Double Your Money Bond

2. Step-Up Interest Bond

3. Retirement Bond

4. Encash Bond

5. Education Bonds

6. Money Multiplier Bonds/Deep Discount Bond

Similar instruments issued by companies are called debentures.

Features:

• Bonds are usually not suitable for an increase in your investment. However, in the rare situation where an investor buys bonds at a lower price just before a decline in interest rates, the resultant drop in rates leads to an increase in the price of the bond, thereby facilitating an increase in your investment. This is called capital appreciation.

• Bonds are suitable for regular income purposes. Depending on the type of bond, an investor may receive interest semi-annually or even monthly, as is the case with monthly-income bonds. Depending on one's capacity to bear risk, one can opt for bonds issued by top-ranking corporates, or that of companies with lower credit ratings. Usually, bonds of top-rated corporates provide lower yield as compared to those issued by companies that are lower in the ratings.

• In times of falling inflation, the real rate of return remains high, but bonds do not offer any protection if prices are rising. This is because they offer a pre-determined rate of interest.

• One can borrow against bonds by pledging the same with a bank. However, borrowings depend on the credit rating of the instrument. For instance, it is easier to borrow against government bonds than against bonds issued by a company with a low credit rating.

• There are specific tax saving bonds in the market that offer various concessions and tax-breaks. Tax-free bonds offer tax relief under Section 88 of the Income Tax Act, 1961. Interest income from bonds, upto a limit of Rs 9,000, is exempt under section 80L of the Income tax Act, plus Rs 3,000 exclusively for interest from government securities. However, if you sell bonds in the secondary market, any capital appreciation is subject to the Capital Gains Tax.

• bonds are rated by specialised credit rating agencies. Credit rating agencies include CARE, CRISIL, ICRA and Fitch. An AAA rating indicates highest level of safety while D or FD indicates the least. The yield on a bond varies inversely with its credit (safety) rating. As mentioned earlier, the safer the instrument, the lower is the rate of interest offered.

Assurance In Bonds:
This depends on the nature of the bonds that have been purchased by the investor. Bonds may be secured or unsecured. Firstly, always check up the credit rating of the issuing company. Not only does this give you a working knowledge of the company's financial health, it also gives you an idea about the risk considerations of the instrument itself.

This knowledge makes for a better understanding of the available choices, and helps you take informed decisions. In secured instruments, you have a right to the assets of the firm in case of default in payment. The principal depends on the company's credit rating and the financial strength.

Selling in the secondary market has its own pitfalls. First, there is the liquidity problem which means that it is a tough job to find a buyer. Second even if you find a buyer, the prices may be at a steep discount to its intrinsic value. Third, you are subject to market forces and, hence, market risk. If interest rates are running high, bond prices will be down and you may well end up incurring losses. On the other hand, Debentures are always secured.

Interest payments depend on the health and credit rating of the issuer. Therefore, it is crucial to check the credit rating and financial health of the issuer before loosening up your purse strings.

If you do invest in bonds issued by the top-rated corporates, rest assured that you will receive your payments on time.

Risks In Bonds:
In certain cases, the issuer has a call option mentioned in the prospectus. This means that after a certain period, the issuer has the option of redeeming the bonds before their maturity. In that case, while you will receive your principal and the interest accrued till that date, you might lose out on the interest that would have accrued on your sum in the future had the bond not been redeemed. Inflation and interest rate fluctuation affect buy, hold, and sell decisions in case of Bonds. Always remember that if interest rates go up, bond prices go down and vice-versa.

Buying, Selling, And Holding Of Bonds:
Investors can subscribe to primary issues of Corporates and Financial Institutions (FIs). It is common practice for FIs and corporates to raise funds for asset financing or capital expenditure through primary bond issues. Some bonds are also available in the secondary market.

The minimum investment for bonds can either be Rs 5,000 or Rs 10,000. However, this amount varies from issue to issue. There is no prescribed upper limit to your investment-you can invest as little or as much as you desire, depending upon your risk perception. Bonds offer a fixed rate of interest.

The duration of a bond issue usually varies between 5 and 7 years.

Liquidity Of A Bond:
Selling in the debt market is an obvious option. Some issues also offer what is known as 'Put and Call option.' Under the Put option, the investor has the option to approach the issuing entity after a specified period (say, three years), and sell back the bond to the issuer.

In the Call option, the company has the right to recall its debt obligation after a particular time frame.

For instance, a company issues a bond at an interest rate of 12 per cent. After 2 years, it finds it can raise the same amount at 10 per cent. The company can now exercise the Call option and recall its debt obligation provided it has declared so in the offer document. Similarly, an investor can exercise his Put option if interest rates have moved up and there are better options available in the market.

Market Value Of A Bond:
Market value of a bond depends on a host of factors such as its yield at maturity, prevailing interest rates, and rating of the issuing entity. Price of a bond will fall if interest rates rise and vice-versa. A change in the credit rating of the issuer can lead to a change in the market price.

Mode Of Holding Bonds:
Bonds are most commonly held in form of physical certificates. Of late, some bond issues provide the option of holding the instrument in demat form; interest payment may also be automatically credited to your bank account.