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What Are Bonds And Different Types Of Bonds?

Banking and Financial awareness is very important from exam point of view as questions are come from this section as well as it is very important from interview point of view because a banking aspirant is expected to have banking and financial awareness knowledge. In this space we will be talking about Bonds and their types. This is a very important topic and we will be discussing it in detail here so make sure you read this article thoroughly as the explanation is in very lucid language so that every student who is not from commerce background can understand it.

What Are BONDS?

Every individual puts a part of his/her salary into something that would help him/her in the long run, this is known as “investment”. Investment is quite essential because unavoidable circumstances can arise anytime and anywhere. People like to invest their money into something which guarantees maximum return and minimum risks. There are different ways in which one can invest money and one such way is to invest in bonds. Bonds are commonly referred to as fixed income securities and are one of three  classes individual investors are usually familiar with, along with stocks  and cash equivalents.

Bonds are basically issued by organizations for a period of more than one year to raise money by borrowing and to do so organizations issue bonds to investors which is more of a financial contract. In this type of contract, the organization promises to pay the principal amount and interest (in the form of coupons) to the holder of the bond after a certain date. (Also called maturity date.

Features of Bonds:

Face Value/ Par Value/ Principal: Denotes the amount of money a holder gets after the bond matures

Coupon/ Interest Rate: Denotes the amount that bond holder receives as interest payments at a certain rate at regular interval. It can be paid monthly, quarterly, or yearly depending on the bond. Depending on interest rates, there can be two types of bonds i.e., fixed-rate bond (interest rate is fixed) and floating-rate bond (flexible interest rate that is marked to market rates through an index).

Maturity: Denotes date in the future on which the investor’s principal amount is repaid.

Issuer: Denotes the entity that borrows money or issues bond to raise funds.

Bond Price: It is different from the face value of the bond. It represent the present discounted value of future cash streams generated by the bond. This computed value represents price of the bond which keeps on fluctuating on daily basis depending on the supply and demand at any moment. Bond Price is dependent on the prevailing interest rates in the market depending on which it can either sell at premium or discounted rate. If the face value is 100 and is selling at 105 then the bond is selling at premium and if 85 is the bond price then it is selling at discount rate.

Types of Bonds

Given below are  the types of bonds:

1) Fixed Rate Bonds

In this the interest remains fixed throughout the tenure which makes it resistant to any changes and fluctuations in the market.

2) Floating Rate Bonds

In Floating rate bonds, the interest rate is not fixed and it keeps on fluctuating as per the current market reference rate.

3) Zero Interest Rate Bonds

In Zero Interest Rate Bonds any regular interest is not paid to the investor and issuers only pay the principal amount to the bond holders.

4) Inflation Linked Bonds

Inflation Linked Bonds are those bonds that are linked to Bonds. The interest rate raised on Inflation linked bonds is generally lower than fixed rate bonds.

5) Perpetual Bonds

The bonds which have no maturity dates are called perpetual bonds and the holders of perpetual bonds enjoy interest throughout.

6) Subordinated Bonds

The Bonds which are at the bottom of the priority table compared to other bonds of the company in case there is a lockdown are called subordinated bonds. If we consider the case of liquidation then subordinated bonds are given less importance as compared to senior bonds which are paid first.

7) Bearer Bonds

Bearer Bonds do not carry the name of the bond holder and anyone who possesses the bond certificate can claim the amount. If the bond certificate gets stolen or misplaced by the bond holder, anyone else with the paper can claim the bond amount.

8) War Bonds

The bonds issued by any government in case of a war are known as war bonds.

9) Serial Bonds

Bonds that mature over a period of time in instalments are known as serial bonds.

10) Climate Bonds

The bonds issued by any government to raise funds when the country faces any adverse changes in climatic conditions are known as climatic bonds.

11) Capital Indexed Bonds

These are bonds, the principal of which is linked to an accepted index of inflation with a view to protecting the Principal amount of the investors from inflation. A 5 year Capital Indexed Bond, was first issued in December 1997 which matured in 2002.

12) Bonds with Call/ Put Options

Bonds can also be issued with features of optionality wherein the issuer can have the option to buy-back (call option) or the investor can have the option to sell the bond (put option) to the issuer during the currency of the bond. It may be noted that such bond may have put only or call only or both options

13) Special Securities

Under the market borrowing program, the Government of India also issues, from time to time, special securities to entities like Oil Marketing Companies, Fertilizer Companies, the Food Corporation of India, etc. (popularly called oil bonds, fertiliser bonds and food bonds respectively) as compensation to these companies in lieu of cash subsidies These securities are usually long dated securities and carry a marginally higher coupon over the yield of the dated securities of comparable maturity. These securities are, however, not eligible as SLR securities but are eligible as collateral for market repo transactions. The beneficiary entities may divest these securities in the secondary market to banks, insurance companies / Primary Dealers, etc., for raising funds.

Government of India has also issued Bank Recapitalisation Bonds to specific Public Sector Banks in 2018. These securities are named as Special GoI security and are non-transferable and are not eligible investment in pursuance of any statutory provisions or directions applicable to investing banks. These securities can be held under HTM portfolio without any limit.

14) STRIPS – Separate Trading of Registered Interest and Principal of Securities.

STRIPS are the securities created by way of separating the cash flows associated with a regular G-Sec i.e. each semi-annual coupon payment and the final principal payment to be received from the issuer, into separate securities. They are essentially Zero Coupon Bonds (ZCBs). However, they are created out of existing securities only and unlike other securities, are not issued through auctions. Stripped securities represent future cash flows (periodic interest and principal repayment) of an underlying coupon bearing bond. Being G-Secs, STRIPS are eligible for SLR. All fixed coupon securities issued by Government of India, irrespective of the year of maturity, are eligible for Stripping/Reconstitution, provided that the securities are reckoned as eligible investment for the purpose of Statutory Liquidity Ratio (SLR) and the securities are transferable.

15)Sovereign Gold Bond (SGB)

SGBs are unique instruments, prices of which are linked to commodity price viz Gold. SGBs are also budgeted in lieu of market borrowing. The calendar of issuance is published indicating tranche description, date of subscription and date of issuance. The Bonds shall be denominated in units of one gram of gold and multiples thereof. Minimum investment in the Bonds shall be one gram with a maximum limit of subscription per fiscal year of 4 kg for individuals, 4 kg for Hindu Undivided Family (HUF) and 20 kg for trusts and similar entities notified by the Government from time to time, provided that (a) in case of joint holding, the above limits shall be applicable to the first applicant only; (b) annual ceiling will include bonds subscribed under different tranches during initial issuance by Government and those purchased from the secondary market; and (c) the ceiling on investment will not include the holdings as collateral by banks and other Financial Institutions. The Bonds shall be repayable on the expiration of eight years from the date of issue of the Bonds

There are bonds categorization on the basis of who issues the bonds :

1.Corporate Bonds: Bonds issued by corporations

2. Municipal bonds: Bonds issued by Municipal corporation.

3. Government Bonds: Marketable securities issued by any sovereign government such as
treasury bills (maturity in less than a year), treasury bonds (maturity in more than 10 years)
and treasury notes (maturity in 1 to 10 years). In 2010, Government of India, in consultation with RBI introduced a new short-term instrument, known as Cash Management Bills (CMBs), to meet the temporary mismatches in the cash flow of the Government of India. The CMBs have the generic character of T-bills but are issued for maturities less than 91 days.

4. Agency bonds: Bonds issued by agencies which are supported by the governments.

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