What is a Bond? Understanding Bonds, Their Types, and How They Work

What Exactly is a Bond?

A bond is a type of Fixed-Income Instrument. When you buy bonds, you lend money to an organization, government, corporation, or municipality. In return, it promises to pay you the money after a certain period with regular interest. You act like a bank, and the bond issuer is the borrower.

Why Do Bonds Exist?

Governments and companies want cash to finance their projects. For example, a government may want to build roads, schools, or hospitals, while a company may want to expand its business enterprise, build a factory, or introduce a new product.

They don't depend solely on banks for that or raise taxes; instead, they use bonds to acquire the much-needed cash. When you purchase a bond, you're helping them reach those goals and earn returns.

How Do Bonds Work?

Here's how it usually works:

• You purchase a bond: Suppose a company sells a bond for Rs.10,000 at an annual interest rate of 5% for 5 years.
• You receive interest: You'll receive Rs.500 (5% of Rs.10,000) each year as interest. It's also called the "coupon".
• You get your money back at maturity: In the end, after 5 years, the company returns the Rs.10,000 you lent them.

Easy, right? You get both regular income through interest and the safety of knowing your principal will come back to you.

Types of Bonds

Not all bonds are the same, and each serves a different purpose. Here are a few common ones:

• Government Bonds: These are issued by governments. In India, they are also called Government Securities or G-Secs. They are considered very safe.
• Corporate Bonds: These are issued by companies. They usually carry a higher interest rate, but the risk is a bit more.
• Municipal Bonds: These are issued by local governments or municipalities for some public project.
• Zero-Coupon Bonds: These do not pay periodic interest. Alternatively, you buy them at a discount and get the full face value at maturity.

Why Should You Invest in Bonds?

Bonds are one of the favorite investment instruments in India for several reasons:

• Stable Income: The regular interest payment creates a steady stream of income.
• Diversification: They balance your investment portfolio, especially when paired with stocks.
• Safety: Bonds are normally safer than stocks and, therefore, a very good fit for conservative investors.

Are Bonds Risk-Free?

Not exactly. Government bonds are considered safe, but corporate bonds carry some risk. The company may default and not pay you back. Moreover, if interest rates increase, the value of your bond may fall if you need to sell before maturity.

The Bottom Line

Bonds are a great avenue of investment that offers steady and safe money growth. Whether retirement savings or simply diversification, bonds could be one of the more stable paths to take for your investments. Now that you've learned the basics, you're ready to take on the world of bonds!