Bonds are debt instruments issued by corporate or government institutions to raise funds to meet their liabilities. In turn they pay the bond holders interest(coupon) and return the face value at maturity.
Bondholders are called creditors to the issuing entity, means in the event of liquidation of the company bondholders are paid before shareholders.
Bonds can be considered as good investment for less risk averse investors who are looking for better return compared to bank fixed deposits.
Before investing in bonds one should be aware of these basic things. Here are a few things you should know.
Bonds come with different maturities ranging from 5 years to 10 years. One needs to choose based on his portfolio requirement and his commitments.
Liquidity is the main constraint in bonds. However, one can pre-maturely withdraw but they will be prone to interest rate risk.
In case if you want to sell your bond during high interest rates, you may have to sell for a lower price. This is because you need to compensate the buyer for the lower coupon on your bond.
While, bonds are listed on exchanges they may not be liquid and selling illiquid bonds in the market may leave you with less value.
Additional Features of the Bonds
Bonds comes with features such as call and put options. In case of call option which gives additional rights to the issuer, so the investors are compensated by paying higher coupon rate.
In such bonds, the bond issuer may decide to call for the bond before its maturity date.
Bonds with put option have more rights to investors. Hence, their coupon rate is less when compared to other non-putable bonds. Individuals with less knowledge should avoid such complicated bonds.
Interest Rates Risk
As bond prices are inversely related to interest rates i.e., when interest rates go up, bond prices go down and vice-versa. So, there is no fixed rule to know the exact return on the bonds as it depend on other factors.
Rating on Bonds
Bonds with AAA rating are considered to be safe instruments. However, one risks could arise anytime after bond is purchased due to change in economy. So, one should look beyond ratings. Don't depend on rating agencies they may be late in updating any latest changes in ratings.
If the rating on bond is low, it means that there are higher chances of issuer getting default or late payment of coupon.
Most of the corporate bonds are taxable investments. However, bonds issued by government and municipal bonds are exempt from tax, means that interest realized on the bonds are not subject tax. Click to know tax free bonds that are free from income tax in India.