29 Jul, 2025
4 mins read
Bonds are one of the most common instruments used by governments, corporations, and institutions to raise capital. For investors, they provide a stable source of income and are often seen as a safer alternative to equities. This blog explains what bonds are, how they work, their key features, and the benefits and drawbacks of investing in them.
A bond is a fixed-income financial instrument that represents a loan made by an investor to a borrower, typically a corporate or government entity. In return for the loan, the issuer agrees to pay the investor interest at regular intervals and to return the principal amount on a specified maturity date.
In simpler terms, when you buy a bond, you are lending money to the issuer in exchange for periodic interest payments and the return of the initial amount at maturity.
Bonds function much like a traditional loan. Here’s how they typically work:
Issue: The issuer offers bonds to raise funds, stating the interest rate (coupon), maturity date, and other terms.
Purchase: Investors buy the bonds at face value or at a premium/discount.
Interest Payments: The issuer pays regular interest, usually semi-annually or annually.
Redemption: On maturity, the principal (face value) is repaid to the investor.
For example, if you buy a bond worth ₹1 lakh with a 7% annual interest rate and a 5-year maturity, you will receive ₹7,000 each year and get back your ₹1 lakh at the end of 5 years.
Bonds have several defining characteristics:
Face Value: The principal amount paid to the investor at maturity.
Coupon Rate: The interest rate paid by the issuer to the bondholder.
Maturity Period: The duration after which the bond is redeemed.
Issuer: The entity raising funds (government, company, etc).
Credit Rating: Indicates the creditworthiness of the bond issuer.
Yield: The effective return an investor receives based on the bond's purchase price and coupon.
Investors consider bonds for various reasons:
Steady Income: Bonds offer fixed and predictable interest payments.
Capital Preservation: Principal is returned at maturity, preserving capital.
Portfolio Diversification: Adding bonds reduces overall risk in an equity-heavy portfolio.
Lower Volatility: Bonds tend to be less volatile than stocks.
Predictable Returns: Returns are generally known in advance.
Several entities issue bonds in India:
Government of India: Through instruments like G-Secs, Treasury Bills.
State Governments: State Development Loans (SDLs).
Public Sector Units (PSUs): For infrastructure and development funding.
Corporations: To raise capital for expansion or operations.
Municipal Bodies: Via municipal bonds for civic projects.
Each type of issuer has a different risk-return profile. Government bonds are considered the safest, while corporate bonds may offer higher yields with added credit risk.
Bonds offer multiple benefits to investors:
Safety: Especially in the case of government-issued bonds.
Regular Income: Predictable cash flow through interest payments.
Diverse Options: Different tenures, issuers, and credit ratings to choose from.
Secondary Market Liquidity: Listed bonds can be traded on exchanges.
Tax Benefits: Certain bonds offer tax exemptions on interest or returns (e.g., tax-free bonds).
Capital Gains Potential: Bonds bought at a discount and sold at a premium may provide gains.
Despite their advantages, bonds are not without drawbacks:
Interest Rate Risk: Bond prices fall when interest rates rise.
Credit Risk: Risk of default by the issuer, especially in lower-rated bonds.
Inflation Risk: Fixed returns may not keep pace with inflation.
Liquidity Risk: Not all bonds are easily tradable.
Reinvestment Risk: Difficulty in reinvesting interest at the same rate if rates fall.
It is important to assess the risk-reward ratio and choose bonds based on financial goals and risk tolerance.
Bonds are a reliable investment avenue, offering safety, income, and diversification. While they may not provide high returns like equities, their stability makes them suitable for conservative investors or those nearing retirement. However, like any investment, bonds come with their set of risks. A balanced portfolio with a mix of equities and bonds can help achieve both growth and stability.
A bond is a loan given by an investor to a company or government, in return for interest payments and the repayment of the loan amount on maturity.
Generally, bonds are considered safer than stocks as they offer fixed returns and are less volatile. However, they may also yield lower returns and are not entirely risk-free.
In India, the main types include government bonds, corporate bonds, municipal bonds, and tax-free bonds.
Yes, the interest earned on bonds is taxable as per the investor's income tax slab. However, some government-issued tax-free bonds offer interest that is exempt from tax.
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