Bonds and Stock : Difference | Type of Bonds
- 29 December 2019 | 873 Views | By Mint2Save
With the ever-changing financial system, India is becoming stronger and more robust in economic terms. The significant economic changes happened in India back in the 1990s. The year marks the beginning of economic reforms, and have witnessed the stability in economic conditions of India
The Government securities entered the Indian economy in the mid-1990s and trading platforms since then, has gained a lot of popularity. Bonds market in India has always been a critical factor in meeting the short term and long-term financial requirements of the industrial sector. Trading mechanisms have improved and updated with the development of technology and new tools for the industry.
The bond market has been an essential contributor in the stable position of the Indian economy. The sector has immense potential for meeting the long-term financial needs of both public and private companies. It acts as a fund-raising sector for different ventures taken out by governments and companies. While they have a glance over the history of the Bonds market, they need to know what Bonds are to understand the rest of the article in detail.
Bonds are a kind of loan between a borrower and the lender. Think of this in simpler terms. When you buy a bond, that means you have lent your money to the entity from which you have taken the bond. This entity can be anyone, including the private companies or even the Government.
It is somewhat similar to getting a loan from a bank where you act as a lender (known as an investor), and the companies and Government act as a borrower. Investors can sell and purchase the bonds in Bonds Market.
In bonds, investors get a regular payment from the borrower as an interest of a specified rate (coupon rate). Companies calculate the coupon rate on the total amount that the issuer has given to the borrower.
The borrower has to pay the interest until the maturity period and once the maturity period is over the borrower returns the entire principal amount to the investor.
Bonds or Stocks- What’s the difference?
Generally, people who have the least knowledge about them tend to confuse it with stocks. However, bonds are very different from stocks. Bonds are a kind of certificate of debt – a debt investment while stocks, on the other hand, is an equity investment.
Bonds are a liability for the company, whereas stocks are assets for them. Companies majorly issue shares while bonds can be issued by both Government or companies.
Bondholders get a fixed amount of interest at the set interval, which makes it a desirable option for those who are looking for safe investment options with fixed income.
The involvement of the Government plays a significant role in making this a reliable investment option. Also, bondholders enjoy more privileges than a shareholder, and probably this might be the reason people mainly prefer to invest in bonds.
As a bondholder, if you have invested a certain amount of money in an organization, you automatically become a debt for them. Companies are required to make payments to lenders on a priority basis, and this acts as additional security for the investors.
What makes the bond a popular investment option?
The primary reason is that they, unlike equity investment, offer greater certainty to people. For people who want to have a stable income and with the least amount of risk and high comfort level of security, bonds become an easy option for them to choose.
The big reasons to invest in bonds are:
- Stable & Secure: If your primary motive of investment is to get a steady level of income, Bonds provide an option for a stable income with minimal risk.
- Diversification: Diversification stated the variety of assets in your portfolio. Investment in bonds either improves the rate of return of your portfolio or minimizes the risk. For example, when you add high-quality bonds to your equity investment portfolio, you’ll attain a greater diversification in the portfolio and also reduce the risk involved
What are the major types of bonds?
Investing in bonds can be both a fascinating and exciting thing for an investor. However, it is equally important for investors to know what are the different types of bonds available to people to invest.
Knowledge of various types of bonds, their features and rates will act beneficiary information in investment procedure. Let us take a look at what are the options available for investors.
Bonds Based on the Type of Issuer
- Government Bonds:
Bonds issued by the Government to raise money to finance the long-term projects or to meet their day to day expenses are known as Government bonds. The Government of the country backs these bonds. It acknowledges the government’s obligation.
The government offers a fixed amount of interest to the investors. Bonds can be issued either for a short period (less than one year) known as treasury bills or for a more extended period (more than a year) known as treasury bonds.
While these bonds offer the high-security option to the investors, the interest offered is generally low.
- Corporate Bonds:
When companies want to expand their business structure of want to invest a more substantial amount in a project, they can issue bonds to the public to raise money from them.
The company can issue bonds according to their requirements. Anyone can buy these bonds. Unlike corporate equities, these bonds do not offer any ownership right to the investor.
These bonds are profoundly affected by the market ups and downs, which makes these a less safe option. But as we know the basic rule of finance, More risk = more income. No doubt, these are a certainly less safe option, but they offer a high amount of interest to the public.
Bonds Based on the Type of Income & Interest
- Fixed-rate Bonds:
As the name suggests, fixed-rate bonds provide a fixed amount of interest to its investors. Till the maturity period, investors enjoy a fixed amount of coupon rate. The majority of government bonds are fixed-rate bonds.
Fixed-rate bonds are generally preferred by people who want a steady income for an extended period.
- Floating rate Bonds:
When bond rates are affected by the market fluctuations, these types of bonds are known as Floating rate Bonds. These bonds have a variable rate of interest which is periodically changed by the companies.
However, there’s a set minimum and maximum value to maintain stability. The significant advantage of investing in bonds with floating rate is that unlike a fixed interest rate investor, when the company increases the prevailing rate of interest, they can enjoy a high amount of interest rate.
- Indexed rate Bonds:
Inflation has a tremendous effect on the economy. Indexed rate bonds are the bonds issued by the organizations which provide a constant return on the investment and eliminates the inflation risk. However, now most of the countries have a firm policy to balance the inflation situation; these bonds have failed to capture the investors’ attention over the period.
- Zero-coupon bonds
Every bond has a specified interest rate, but zero-coupon bonds do not carry any interest rate.
The government or companies offer bonds on the discount rate on the face value of the bond and maturity investors get the actual face value of the bond, and the difference between the two will be the interest amount.
Forex, Government, issue a Rs 1000/- bond at a discount of Rs 800/- but at the maturity, the investor will get the face value of the bond, i.e. he/she will get Rs 1000/- on maturity.
The last zero-coupon bond issued in 1996 and since then, they haven’t issued such securities.
- Tax-saving bonds
Investment in these bonds will exempt you from paying interest on the interest income. The investors enjoy this exemption until the maturity period.
So, while there are other bonds available, these are some significant bonds that are worth knowing. You may now have understood the basics of bonds and which one will be the investment option for you.