Investing in bonds

If you are a retired person or a risk-averse individual looking for steady return over the long term, you should consider investing in bonds issued by the government or by corporate entities. Investments in bonds provide steady income to the investor in the form of interest payments at regular intervals. The frequency of interest payment is pre-decided by the issuer and it can be monthly, quarterly, half-yearly or yearly or on the date of maturity. In industry parlance, the interest rate is also known as the coupon rate. There are zero coupon bonds that do not pay any interest to the investor, but these are issued at a discount to the face value (FV) of the bond. So, if the FV of the bond is Rs 1,000 and the maturity period is 5 years, the bond issuer may issue the bond for a price of Rs 600 or any other price, depending on the coupon rate.

The corporate bonds can be issued by private companies or listed corporations. These bonds may or may not be listed on the stock exchanges. Needless to say, listed bonds provide greater liquidity to the investor. Bonds are mandatorily required to be rated by the rating agencies. The bonds are rated as ‘AA’, ‘AAA’, and so on and the rating level determines safety of capital, so higher the rating, higher the safety of capital. However, the returns may be inversely linked to the ratings, so bonds with higher rating may offer lower returns, and vice versa.

In the case of listed bonds, the prices of bonds fluctuate according to the movement in interest rates. The bond prices and interest rates are inversely linked, so when interest rates go up, bond prices fall, and vice versa. These tradeable bonds are subject to marked-to-market profits or losses, depending on the interest rate movement, but if the investor holds these bonds till maturity he will get the principal amount back.

The returns on bonds may be equal to or slightly higher than fixed deposits of banks. The interest earned on bonds is taxable and will be added to the overall income of the investor and taxed as per the tax slab of the investor. However, interest income from tax-free bonds issued by the government or public sector corporations are tax free, but the rate of interest offered on these bonds would be lower than taxable bonds. If an investor makes capital gains by trading in bonds, such gains are taxable.