BONDS


 WHAT IS FINANCIAL BOND

A financial bond, often simply referred to as a "bond," is a debt security issued by a government or corporation to raise capital. When an investor purchases a bond, they are essentially lending money to the issuer for a specified period of time, known as the bond's term or maturity. In return, the issuer agrees to pay the investor a fixed interest rate, known as the coupon rate, at regular intervals until the bond matures. At maturity, the issuer repays the principal amount borrowed to the bondholder.

WHAT IS THE HISTORY OF BONDS IN INDIA

In India, the first borrowing was made in 1867 for the purposes of railway construction. Apart from that a rise in public debt was also encountered during the first world war. Interest rate of bonds varied in India from time to time. In 1857 it came down to 5% and gradually to 4% in 1871.

Characteristics of Bonds

  • Face value or Par Value: The value of the bond at maturity and the reference amount the bond issuer uses when calculating interest payments.
  • Coupon Rate: The rate of interest the bond issuer will pay on the face value of the bond, expressed as a percentage.

  • Coupon Dates: The dates on which the bond issuer will make interest payments.
  • Maturity Date: The date on which the bond will mature and the bond issuer will pay the bondholder the face value of the bond.
  • Issue Price: The price at which the bond issuer originally sells the bonds. In many cases, bonds are issued at par.
EXAMPLE OF BOND IN FINANCE

Durga bought a Rs1,000 bond with a maturity of 2 years, at a fixed coupon rate of 5%. In 1 year, Durga  will receive a Rs50 coupon/bond yield. In 2 years, when her bond matures, she will receive Rs1,050 back, which includes: Her par value of Rs1,000.


Advantages and Disadvantage of Bonds


Advantages:


  • Income Stream: Bonds provide a steady income stream through periodic interest payments.

  • Capital Preservation: Generally, bonds are considered less risky than stocks, making them suitable for capital preservation.

  • Diversification: Adding bonds to a portfolio can help diversify risk, especially when combined with stocks.

  • Predictable Returns: Unlike stocks, the returns from bonds are typically fixed, providing more predictability.

  • Tax Benefits: Municipal bonds, for example, offer tax advantages like exemption from federal taxes.

  • Disadvantages:

  • Interest Rate Risk: When interest rates rise, bond prices typically fall, which can lead to capital losses.

  • Inflation Risk: If inflation exceeds the bond's interest rate, the purchasing power of its payments decreases.

  • Credit Risk: There's a risk of default if the issuer fails to make interest or principal payments.

  • Liquidity Risk: Some bonds may lack liquidity, making it difficult to sell them quickly without affecting their price.

  • Reinvestment Risk: When bonds mature or are called, investors may have to reinvest at lower interest rates, reducing income.


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