What are Bonds?
Bonds are investments where you loan money to companies or governments for a fixed period, earning interest in return. Typically issued as Non-Convertible Debentures (NCDs), they remain less risky than stocks and provide a stable income stream. Bonds have varying maturity dates and fixed interest rates (coupon rates) established at issuance. Bondholders receive regular interest payments until maturity when the principal is repaid. Incorporating bonds into an investment portfolio can help diversify and mitigate risk.
How do bonds work?
Bonds allow borrowers like corporations or governments to raise funds from investors. When you purchase a bond, it has a face value, which is the amount you’ll be repaid at maturity. For example, if you buy a bond with a face value of Rs 10,000 and an 8% coupon rate, you’ll receive Rs 800 annually for 10 years and the principal back at maturity. Coupon payments can be made monthly, semi-annually, or annually.
The coupon rate is determined at issuance, influenced by market interest rates, issuer creditworthiness, and bond duration. When interest rates rise, new bonds offer higher rates, making existing bonds less attractive, which lowers their market value, and vice versa when rates fall. Bonds can be sold on secondary markets, providing liquidity to investors.
At maturity, the borrower repays the face value, and interest payments cease. Bonds can also be redeemed early, paying the face value plus any accrued interest. Corporate bonds are riskier if the issuer has weak financials due to a higher chance of default. Overall, bonds can enhance a diversified portfolio by providing steady income and reducing risk.
Credit Risk
The risk that the issuer may default on payments. Assessing the issuer's creditworthiness is crucial.
Interest Rate Risk
If interest rates rise after you purchase a bond, its value will decrease.
Inflation Risk
Inflation can erode the purchasing power of your bond's interest payments and principal.
Liquidity Risk
There may be challenges in selling your bond quickly or at a fair price.
Call Risk
The issuer may redeem the bond before maturity, potentially disadvantaging the investor.
Understanding these risks is essential for making informed investment decisions and effectively managing risk in your portfolio.
What are Sovereign Gold Bonds
Sovereign Gold Bonds are government securities valued in grams of gold that serve as alternatives to physical gold ownership. Investors pay the issue price in cash, and upon maturity, the bonds are redeemed for cash. These bonds are issued by the Reserve Bank of India on behalf of the Government of India.