Bonds- Defination, Characteristics, Advantages and

Disadvantages of bonds

S.Y. MCOM (BANKING & FINANCE) –IAPM

H.R. COLLEGE OF COMMERCE & ECONOMICS

SUBMITTED TO
PROF. BHARTI JETHANI

SUBMITTED BY
NAME: - DISHA AGARWAL
ROLL NO.- 01
 H.R. COLLEGE OF COMMERCE & ECONOMICS
S.Y. MCOM (BANKING & FINANCE)

Date – 13TH OCTOBER 2023

TABLE OF CONTENTS

SR NO. TOPIC

1. INTRODUCTION

2. Characteristics

3. FEATURES, ADVANTAGES & DISADVANTAGES OF BONDS

4. Types of Bonds

5. REASONS BONDS ARE A GOOD INVESTMENT

RISKS ASSOCIATED WITH BONDS

6.

7. IMPORTANCE OF BOND RATING

8. GREEN BONDS – CHALLENGES, FEATURES, ADVANTAGES &

DISADVANTAGES

9. CONCLUSION
 Declaration by Learner

I the undersigned Miss Disha Agarwal of the learner Roll no -01 SY Banff here
by, declare that the work embodied in this project work “BONDS”, forms my
own contributor to the research work carried out under the guidance of Name of
the Guiding Teacher is a result of my own research work and has not been
previously subsided to any other University for any other Degree/ Diploma to
this or any other University. Wherever reference has been made to previous
works of others, it has been clearly indicated as such and included in the
bibliography. The learner has complied to the provisions of the UGC (Promon
of Academic Integrity and Revenson of Plagiarism in Higher Decagonal Instant)
Regulon 2018.

I, here by further declare that all informant of this document has been obtained
and presented in accordance with academic rules and ethical conduct.

Name and Signature of the learner

Disha

Cornfield by Name and Signature of the Guiding Teacher

Ms. Bharthi
 INTRODUCTION
What Is a Bond?

A bond is a fixed-income instrument that represents a loan made by an investor

to a borrower (typically corporate or governmental). A bond could be thought of
as an I.O.U. between the lender and borrower that includes the details of the
loan and its payments. Bonds are used by companies, municipalities, states, and
sovereign governments to finance projects and operations. Owners of bonds are
debtholders, or creditors, of the issuer.

Bond details include the end date when the principal of the loan is due to be
paid to the bond owner and usually include the terms for variable or fixed
interest payments made by the borrower.

KEY TAKEAWAYS
Bonds are units of corporate debt issued by companies and securitized as
tradeable assets.
A bond is referred to as a fixed-income instrument since bonds traditionally
paid a fixed interest rate (coupon) to debtholders.
Variable or floating interest rates are also now quite common.
Bond prices are inversely correlated with interest rates: when rates go up, bond
prices fall and vice-versa.
Bonds have maturity dates at which point the principal amount must be paid
back in full or risk default.
What are Bonds in India?
In India, bonds are issued by companies and government entities to raise money for
various purposes, such as financing infrastructure projects, expanding business
operations, or managing budget deficits.

Bonds are issued for a fixed term, usually ranging from a few years to several
decades, and pay a fixed interest rate to investors.

How Does Bond Investment Work?

Bond investments work differently than stock investments. Investing in bonds is like
lending money to a company or the government.

When you buy a bond, you are basically loaning money to the issuer of the bond, who
promises to pay you back the borrowed amount with interest at a later date.

This interest is called the coupon rate, and it’s usually paid out to the bondholder
twice a year until the bond matures.

The bond market in India works through a process called auctions. The government or
companies issue bonds, which are then auctioned to the highest bidder. Retail
investors can participate in these auctions through their brokers, who bid on their
behalf. The winning bidder receives the bond and pays the bid amount to the issuer.

Once you have purchased a bond, it is held in your Demat account, just like stocks.
You can sell the bond in the secondary market if you need to liquidate your
investment before the maturity date. The price of the bond in the secondary market
depends on several factors, such as interest rates, the credit rating of the issuer, and the
time remaining until maturity.

Overall, investing in bonds is a good way to earn a fixed income stream while
preserving your capital. It is a relatively safe investment option that can provide
steady returns over the long term. However, it’s important to understand the risks
associated with bond investments and choose the right type of bond based on your
investment goals and risk appetite.
Characteristics of Bonds
Most bonds share some common basic characteristics including:

Face value (par value) is the money amount the bond will be worth at maturity; it is
also the reference amount the bond issuer uses when calculating interest payments.
For example, say an investor purchases a bond at a premium of $1,090, and another
investor buys the same bond later when it is trading at a discount for $980. When the
bond matures, both investors will receive the $1,000 face value of the bond.

The coupon rate is the rate of interest the bond issuer will pay on the face value of the
bond, expressed as a percentage.1 For example, a 5% coupon rate means that
bondholders will receive 5% x $1,000 face value = $50 every year.

Coupon dates are the dates on which the bond issuer will make interest payments.
Payments can be made in any interval, but the standard is semiannual payments.

The maturity date is the date on which the bond will mature and the bond issuer will
pay the bondholder the face value of the bond.

The issue price is the price at which the bond issuer originally sells the bonds. In
many cases, bonds are issued at par.

Two features of a bond—credit quality and time to maturity—are the principal

determinants of a bond's coupon rate. If the issuer has a poor credit rating, the risk of
default is greater, and these bonds pay more interest. Bonds that have a very long
maturity date also usually pay a higher interest rate. This higher compensation is
because the bondholder is more exposed to interest rate and inflation risks for an
extended period.

Credit ratings for a company and its bonds are generated by credit rating agencies like
Standard and Poor’s, Moody’s, and Fitch Ratings. The very highest quality bonds are
called “investment grade” and include debt issued by the U.S. government and very
stable companies, such as many utilities.

Bonds that are not considered investment grade but are not in default are called “high
yield” or “junk” bonds. These bonds have a higher risk of default in the future and
investors demand a higher coupon payment to compensate them for that risk.3
Bonds and bond portfolios will rise or fall in value as interest rates change. The
sensitivity to changes in the interest rate environment is called “duration.” The use of
the term duration in this context can be confusing to new bond investors because it
does not refer to the length of time the bond has before maturity. Instead, duration
describes how much a bond’s price will rise or fall with a change in interest rates.

The rate of change of a bond’s or bond portfolio’s sensitivity to interest rates

(duration) is called “convexity.” These factors are difficult to calculate, and the
analysis required is usually done by professionals.

Categories of Bonds
There are four primary categories of bonds sold in the markets. However, you may
also see foreign bonds issued by global corporations and governments on some
platforms.

Corporate bonds are issued by companies. Companies issue bonds rather than seek
bank loans for debt financing in many cases because bond markets offer more
favorable terms and lower interest rates.

Municipal bonds are issued by states and municipalities. Some municipal bonds offer
tax-free coupon income for investors.

Government bonds such as those issued by the U.S. Treasury. Bonds issued by the
Treasury with a year or less to maturity are called “Bills,” bonds issued with one–10
years to maturity are called “notes,” and bonds issued with more than 10 years to
maturity are called “bonds.” The entire category of bonds issued by a government
treasury is often collectively referred to as "treasuries." Government bonds issued by
national governments may be referred to as sovereign debt.

Agency bonds are those issued by government-affiliated organizations such as Fannie

Mae or Freddie Mac.
Varieties of Bonds
The bonds available for investors come in many different varieties. They can be
separated by the rate or type of interest or coupon payment, by being recalled by the
issuer, or because they have other attributes. Below, we list some of the most common
variations:

Zero-Coupon Bonds

Zero-coupon bonds (Z-bonds) do not pay coupon payments and instead are issued at a
discount to their par value that will generate a return once the bondholder is paid the
full face value when the bond matures. U.S. Treasury bills are a zero-coupon bond.4

Convertible Bonds

Convertible bonds are debt instruments with an embedded option that allows
bondholders to convert their debt into stock (equity) at some point, depending on
certain conditions like the share price.5 For example, imagine a company that needs to
borrow $1 million to fund a new project. They could borrow by issuing bonds with a
12% coupon that matures in 10 years. However, if they knew that there were some
investors willing to buy bonds with an 8% coupon that allowed them to convert the
bond into stock if the stock’s price rose above a certain value, they might prefer to
issue those.

The convertible bond may be the best solution for the company because they would
have lower interest payments while the project was in its early stages. If the investors
converted their bonds, the other shareholders would be diluted, but the company
would not have to pay any more interest or the principal of the bond.

The investors who purchased a convertible bond may think this is a great solution
because they can profit from the upside in the stock if the project is successful. They
are taking more risk by accepting a lower coupon payment, but the potential reward if
the bonds are converted could make that trade-off acceptable.
Callable Bonds

Callable bonds also have an embedded option, but it is different than what is found in
a convertible bond. A callable bond is one that can be “called” back by the company
before it matures.6 Assume that a company has borrowed $1 million by issuing bonds
with a 10% coupon that mature in 10 years. If interest rates decline (or the company’s
credit rating improves) in year five when the company could borrow for 8%, they will
call or buy the bonds back from the bondholders for the principal amount and reissue
new bonds at a lower coupon rate.

A callable bond is riskier for the bond buyer because the bond is more likely to be
called when it is rising in value. Remember, when interest rates are falling, bond
prices rise. Because of this, callable bonds are not as valuable as bonds that aren’t
callable with the same maturity, credit rating, and coupon rate.

Puttable Bond

A puttable bond allows the bondholders to put or sell the bond back to the company
before it has matured. This is valuable for investors who are worried that a bond may
fall in value, or if they think interest rates will rise and they want to get their principal
back before the bond falls in value.

The bond issuer may include a put option in the bond that benefits the bondholders in
return for a lower coupon rate or just to induce the bond sellers to make the initial
loan. A puttable bond usually trades at a higher value than a bond without a put option
but with the same credit rating, maturity, and coupon rate because it is more valuable
to the bondholders.

The possible combinations of embedded puts, calls, and convertibility rights in a bond
are endless and each one is unique. There isn’t a strict standard for each of these rights
and some bonds will contain more than one kind of “option,” which can make
comparisons difficult. Generally, individual investors rely on bond professionals to
select individual bonds or bond funds that meet their investing goals.
How Bonds Are Priced

The market prices bonds are based on their particular characteristics. A bond's price
changes on a daily basis, just like that of any other publicly traded security, where
supply and demand at any given moment determine that observed price.

But there is a logic to how bonds are valued. Up to this point, we've talked about
bonds as if every investor holds them to maturity. It's true that if you do this you're
guaranteed to get your principal back plus interest; however, a bond does not have to
be held to maturity. At any time, a bondholder can sell their bonds in the open market,
where the price can fluctuate, sometimes dramatically.

The price of a bond changes in response to changes in interest rates in the economy.
This is due to the fact that for a fixed-rate bond, the issuer has promised to pay a
coupon based on the face value of the bond—so for a $1,000 par, 10% annual coupon
bond, the issuer will pay the bondholder $100 each year.

Say that prevailing interest rates are also 10% at the time that this bond is issued, as
determined by the rate on a short-term government bond. An investor would be
indifferent to investing in the corporate bond or the government bond, since both
would return $100. However, imagine a little while later, that the economy has taken a
turn for the worse and interest rates dropped to 5%. Now, the investor can only
receive $50 from the government bond but would still receive $100 from the corporate
bond.

This difference makes the corporate bond much more attractive. So investors in the
market will bid up to the price of the bond until it trades at a premium that equalizes
the prevailing interest rate environment—in this case, the bond will trade at a price of
$2,000 so that the $100 coupon represents 5%. Likewise, if interest rates soared to
15%, then an investor could make $150 from the government bond and would not pay
$1,000 to earn just $100. This bond would be sold until it reached a price that
equalized the yields, in this case to a price of $666.67.
Bond Prices and Interest Rates

This is why the famous statement that a bond’s price varies inversely with interest
rates works. When interest rates go up, bond prices fall in order to have the effect of
equalizing the interest rate on the bond with prevailing rates, and vice versa.

Another way of illustrating this concept is to consider what the yield on our bond
would be given a price change, instead of given an interest rate change. For example,
if the price were to go down from $1,000 to $800, then the yield goes up to 12.5%.

This happens because you are getting the same guaranteed $100 on an asset that is
worth $800 ($100/$800). Conversely, if the bond goes up in price to $1,200, the yield
shrinks to 8.33% ($100/$1,200)

The importance of bond rating

The bond rating is an important factor to consider when investing in bonds. Bond
rating agencies, such as CRISIL and ICRA, rate bonds based on the issuer’s
creditworthiness, financial health, and ability to repay the debt.

The rating agencies assign a score to the bond, which ranges from AAA (highest
creditworthiness) to D (default). You should choose bonds with a higher credit rating,
as they are less risky and more likely to be repaid.

Who Issues Bonds?

Bonds are debt instruments and represent loans made to the issuer.
Governments (at all levels) and corporations commonly use bonds in order
to borrow money. Governments need to fund roads, schools, dams, or
other infrastructure. The sudden expense of war may also demand the
need to raise funds.

Similarly, corporations will often borrow to grow their business, to buy

property and equipment, to undertake profitable projects, for research and
development, or to hire employees. The problem that large organizations
run into is that they typically need far more money than the average bank
can provide.

Bonds provide a solution by allowing many individual investors to assume

the role of the lender. Indeed, public debt markets let thousands of
investors each lend a portion of the capital needed. Moreover, markets
allow lenders to sell their bonds to other investors or to buy bonds from
other individuals—long after the original issuing organization raised capital.

3 Reasons Bonds Are a Good Investment

In terms of trading, there are benefits bonds can offer that other long-term
investments can’t. Here are three reasons bonds can be a good
investment.

Bonds Provide Fixed Income

Bonds are another way to grow your money, providing a reliable income
stream. Bonds are less volatile than stock market investments.

With the bond markets, even when interest rates are low, there are still
options to make sure you’re hitting your income targets.

Bonds Allow You to Diversify Your Portfolio

Diversifying your portfolio means you’re making sure you’re not putting all
of your eggs in one basket. By investing in a variety of products, you lower
your risk of losing out on a return.

For example, if you’re already trading on the stock market, it wouldn’t hurt
to consider adding bonds to your investment strategy. When the stock
market isn’t doing well, you can lean on your bonds to preserve your
capital until the stock market has an upswing.
Bonds Provide Tax Benefits

Bonds offer tax benefits. If you trade bonds from U.S. Treasuries, you can
rest easy knowing that this income is tax-free on state and local levels.

Municipal bonds are tax-free at the federal level. And if you buy a
municipal bond issued by the state you live in, you won’t need to pay state
tax on it either.

Types of Bonds to Invest In

Think of bonds like a bank loan, but you’re the bank that benefits from the
interest charged. The difference in types of bonds lies in which entity
issues the bond and how the funds are used. Here are four main types of
bonds.

1. Treasury Bonds

Treasury bonds or Treasury bills are known as the highest-quality

securities you can get. They are issued by the U.S. Department of the
Treasury and have a maturity date that can range from 10 to 30 years.

When your government bond reaches maturity, the principal and interest
will be repaid. It will also stop earning interest payments.

You won’t need to pay state or local taxes on the interest earned by these
government bonds. Since they’re backed by the government, there is little
credit risk or risk of default.

2. Sovereign Bonds

Sovereign bonds are also issued by the federal government and can be
denominated in the U.S. dollar or in a global reserve currency. The
government uses sovereign bonds to fund government spending
programs. There are different types of sovereign bonds, such as agency
bonds and savings bonds.

3. Municipal Bonds

Municipal bonds are also issued by state and local governments. They’re
used to fund the construction of public projects like schools, housing,
highways and sewer systems.

Different types of municipal bonds exist — general obligations bonds and

revenue bonds. If you trade municipal bonds, note they are exempt from
federal income tax. Your bond may be exempt from state and local taxes
as well if you live in the issuing state.

In some cases, your bond may be subject to federal, state and local
alternative minimum tax. Although these bonds are issued by the
government, municipal bonds pose a higher risk because local
governments are more likely to go bankrupt than the federal government.

4. Corporate Bonds

Corporate bonds are issued by corporations to fund business expansions

and large capital investments. Overall, this is a less predictable type of
bond because the risk depends on the financial outlook and reputation of
the company.

But corporate bonds can also provide higher rewards for your investment.
Another corporate option is convertible bonds — corporate bonds that can
become company stock.

Should You Invest in Bonds When You Are Young?

It’s a myth that you can’t start investing when you have student debt on
your back. If you’re a young investor, you have time on your side, and you
can reinvest what you earn to generate wealth over time. Young investors
also have the time to assume more risk. Once you’re close to retirement
age, you should decrease your risk in favor of earning potential and
security.

Investing in bonds provides a low-risk way to dip your toes in the water. A
buy-and-hold strategy allows you to buy a bond and hold onto it until it
reaches maturity. By doing this, the only way you or a bondholder can lose
money is if the issuing entity goes bankrupt and can’t repay.
Benefits of Investing in Bonds
Investing in bonds offers various benefits to investors, including:

Steady income: Bonds offer a fixed interest rate, which provides investors
with a steady income stream.

Less Volatility: The value of bonds can fluctuate based on current interest
and inflation rates, but they are generally more stable than stocks.

Assurance: Bonds also have credit ratings assigned by agencies like

CRISIL, providing you assurance while selecting bonds.

Less risky: Bonds are less risky than stocks because, in case of liquidation
of a company, bondholders get paid on priority before shareholders.

Drawbacks of Investing in Bonds

While investing in bonds offers various benefits, there are also some
drawbacks to consider, such as:

Low returns: Bonds offer lower returns than stocks and other high-risk
investments, such as mutual funds and real estate.

Larger amount requirement: Some bonds require a larger sum of

investment, making them unaffordable for some investors

Low liquidity: Bonds come with a lock-in period. If you want to sell the bond
before its maturity date, you may not be able to find a buyer.

]
Risks Associated with Investing in Bonds
Three primary risks that you need to know before investing in bonds.

1. Interest rate risk: Bond prices are inversely proportional to interest

rates. When interest rates go up, bond prices go down, and vice versa.
The longer the maturity of the bond, the more its price fluctuates due to
interest rate changes.
2. Credit risk: Credit risk refers to the possibility of the issuer defaulting
on their payments. If the issuer of the bond defaults, you may lose some
or all of your investment.
3. Liquidity risk: Liquidity risk refers to the possibility of not being able
to sell the bond when you want to. If the bond is not liquid, it may be
challenging to sell it, and you may have to sell it at a lower price than
you anticipated.

Conclusion
Investing in bonds in India is an excellent option for you if you are looking for a
stable source of income with relatively lower risks.

However, you must keep in mind your investment goal, investment horizon, and
bond’s credibility (bond rating can help) before investing your money in bonds.