When you search Google for ‘bond’, the first thing that comes up is ‘Bond movies’. Here, we will not be talking about that Bond. We want to tell you about the bond that will give you safe and stable returns, both in the long-term and short-term. Let’s get started.
What is a bond?
In simple terms, a bond is a loan where you are the lender and you are paid a fee for lending the money. The borrower could be the Government or a company.
What is the value of a bond?
Par Value, also known as face value, is the value written on the bond certificate. Bonds are generally issued above the par value (issued at ‘premium’) or below the par value (issued at ‘discount’).
What is the interest that you receive known as?
The rate at which you receive interest on your bond is known as the coupon rate. Coupon rate is essentially the interest paid for the bond. This is usually expressed as a percentage and is applied on the par value of the bond to determine the amount to be paid as interest. For example, a bond with par value of Rs. 1000 and a coupon rate of 8% would give an interest of Rs.80 (1000 x 0.08). This is irrespective of whether the bond was issued above or below the par value.
Till what date is the bond valid?
The date on which the money that you lent becomes due is called the maturity date. Your principal will be returned to you on this date.
Will you get back exactly the same amount as the face value of the bond?
The price or amount repaid to you on the maturity date is called the redemption amount. Redemption or repayment can be at par, above par or below par. In order to encourage investors to stay invested for long periods, companies might offer to redeem bonds above par (at a premium) but the coupon rate would be a bit lower than bonds redeemed at par or at a discount.
If you are planning to buy your bond in the secondary market, what should you consider?
The secondary market is the market that bonds come to for resale after their initial issue. In case you were unable to buy a bond when it was issued, you can buy it from the secondary market. Apart from the price offered, you must look at the Yield to Maturity or YTM. This is the rate of return you can expect from a bond if you hold it till maturity. YTM varies based on the par value, current market price, coupon rate and time to maturity of the bond. It assumes that all coupon payments are reinvested at the same rate. If a bond’s YTM is greater than its coupon rate, then the bond is said to be selling at a discount. If the vice versa is true, the bond is selling at a premium. If both the YTM and coupon rate are equal, the bond is selling at par. It is best to buy a bond with a good YTM. There are some bonds known as callable bonds. These bonds will be redeemed before maturity and the date of redemption will be decided by the issuer, which is usually a company. For these bonds, you need to look at yield to call. This is the yield on your bond if you were to hold it until the call date. This is only for callable bonds where the bond is redeemed before the maturity date. It is calculated based on the time to call, coupon rate, and market price.
Another thing that you need to look at is the duration of the bond. Duration is the time it takes for a bond to repay its true cost. It is a weighted average time to maturity of all cash flows of the bond. The longer the duration, the riskier the bond, as it has greater chances of getting affected by interest rate changes. It is also viewed as a percentage change in the value of the bond as a result of a 1% change in the interest rate. For example, a bond with a duration of 4 years would fall by 4% if the interest rate rises by 1%. So, long-term bonds are riskier than short-term bonds. Choose the duration based on your risk profile.
Which bonds are said to be in default?
A bond whose interest payments have ceased and principal has not been redeemed due to financial problems of the issuer, is said to be in default.
Wised up about bonds? Start by buying Government bonds, then you can move to bonds issued by companies. Understand that company bonds are riskier than Government bonds. However, Government bonds as usually as safe as bank Fixed Deposits.