What Is Bond: Meaning, Types, Features & How Bonds Work For Investors

Key Highlights
 

1. Bonds provide a passive income source and also reimburse or protect the principal amount when held to maturity. 
    
2. The returns in bonds change as per the interest rate, so the income can become unpredictable for months. 
    
3. Bond features like coupon maturity and credit rating determine yield and sensitivity to interest rate changes.

A bond is just like any other investment, which is safe and guarantees stable returns. It works like a loan that you give to a company or government. In return, they promise to pay you back with interest. 

For example, you have ₹1,00,000 and you decide to buy different types of bonds. Each offers different interest rates, ranging from 6.5% to 8.0% with varying tenures. 

The table below shows how each bond type pays yearly, along with data like investment amount, interest rates and tenures. 
 

With these 3 bonds, you can easily earn  ₹7,110 yearly. Also, you don’t need to track them like the stock market. These may offer low interest rates but guarantee 100% safety.

There are many types of bonds with distinct features and working. Let’s learn about the major types in this blog.

Types of Bonds

Bonds come in various forms depending on who issues them and how they are structured. Let’s look at each type in this section.

1. Based on Who Issues Them
    

   1. Government Bonds

These bonds are issued by the government to raise money for public projects. They are considered extremely safe because the government backs them.

For example, the Indian government issues G-Secs like the 8.24% GS 2018 bond, which was issued in 2008 and matured in 2018. This had a fixed coupon of 8.24%.

2. Corporate Bonds
    

These are issued by private companies needing funds, offering higher returns but with more risk than government bonds.
For example, Tesla raised $2.03 billion via a follow-on stock offering in 2020. This increased its share count and offered a higher return potential.

3. Municipal/Agency Bonds
    

By the name it suggests, these are issued by cities or public agencies to fund local infrastructure like roads or schools. Some of them come with tax benefits.

For example, in India, both central and state governments issue municipal bonds like State Development Loans (SDL) and G-Secs to finance state-level projects.
 

2. Based on Structure
    

   1. Zero-Coupon Bonds
       

These don’t pay interest regularly. Instead, you buy them at a discount and receive the full face value at maturity.

For example, you pay ₹20,000 today and get ₹1,00,000 after 20 years. The profit os ₹80,000 is given at once and not regularly. 

2. Convertible Bonds
    

These can be bought as bonds, but can be turned into company shares later. This also offers coupon income plus stock benefits.
For example, in 2014, Tesla issued $2 billion worth of convertible bonds that could be turned into equity. This decision was made to combine debt safety and equity potential. 

3. Callable Bonds
    

Companies can repay these before they mature, often offering higher interest rates as compensation.
For example, India issued the 6.72% GS 2012 bond in 2002, which included both call and put options. This enabled early redemption. 

4. Green Bonds
    

These are bonds where the funds raised must support environmental or sustainability projects.

For example, the World Bank’s Green Bond program has issued over US$20 billion across 230+ bonds in 28 currencies to support climate-mitigation projects.
 

This table gives a brief on the types of bonds.
 

Understanding these types helps investors invest safely, plan an income, and have an idea about the growth potential.

Key Features of Bonds

In this section, we will see what makes bonds so special and preferred among all other types of investments. 

1. Face Value (Par Value)

This is the principal amount that the investor will receive back at maturity. Most bonds are issued with a standard face value (e.g., ₹1,000).
 For example, if you buy a bond with a face value of ₹1,000, the company will repay you ₹1,000 at maturity, regardless of the market price you paid for it.

2. Coupon Rate

The coupon rate is the fixed or floating interest the issuer pays to the bondholder, usually annually or semi-annually. For example, A bond with a face value of ₹1,000 and a 6% coupon rate will pay you ₹60 every year until maturity.

3. Maturity Date and Duration

The maturity date is when the bond issuer repays the principal. Duration shows how sensitive the bond is to interest rate changes.
For example, if you buy a 5-year bond with a face value of ₹1,000, you’ll receive interest for 5 years and get ₹1,000 back at the end of year 5.

4. Credit Rating

Credit ratings measure how safe a bond is. Higher ratings (AAA) mean lower risk and lower interest; lower ratings (BB or below) mean higher risk and higher interest.
For example, a company with an AAA rating might issue a bond at 6% interest, while a company with a BB rating may need to offer 10% to attract buyers.

5. Liquidity

Liquidity means how easily you can sell the bond before maturity. Some bonds trade actively, others don’t.
For example, a government bond can usually be sold quickly in the market at a fair price. However, a small company’s bond may be harder to sell without taking a loss.

How does Bond work? 

You, as an investor, lend them money, earn interest regularly, and get your principal back at maturity. Let’s see how this works in detail, step by step.

1. How Bonds Function

When you buy a bond, you are lending money to the issuer. They promise to pay interest (coupon) regularly and return the principal (face value) when the bond matures.

For example, you buy a bond with a face value of ₹1,000 and an 8% coupon rate, maturing in 5 years. Each year, you earn ₹80, and at the end of 5 years, you receive your ₹1,000 back. This shows how bonds provide steady income plus principal repayment.

The table summarises this example.
 

You earn interest regularly and get your principal back at maturity. Bonds are predictable for steady income.

2. Price vs. Interest Rates

Bond prices move inversely to market interest rates. When interest rates rise, existing bonds with lower coupons become less attractive, so their market price falls. When rates fall, your bond becomes more valuable, and its price rises.

For example, 
 

• If market interest rates rise to 10%, your 8% bond is less appealing. Its price may drop to ₹950 if you sell early.
   
• If rates fall to 6%, your bond is more attractive, and its price could rise to ₹1,050.

This demonstrates how interest rate changes directly affect bond market prices.
 

3. Yield Calculations

Yields help investors understand the bond’s return.

• Current Yield measures income relative to the bond’s current market price.
   
• Yield to Maturity (YTM) estimates total return if the bond is held until maturity, including both interest and any gain/loss from the bond’s price.
   

For example, if your bond’s market price drops to ₹950, 

1. The Current Yield = ₹80 ÷ ₹950 = 8.42% (approximately), slightly higher than the coupon.
    
2. If held to maturity at ₹1,000, the YTM = 8%. This shows the total expected return, including all interest payments.

The table below summarises this step.
 

Yields help compare bonds and see real return potential. Current yield adjusts for market price, as YTM shows total earnings if held to maturity.

Conclusion 

Most people invest in bonds because they offer a monthly payment, which works like a passive income. It also gives principal repayment and predictable returns. However, bonds do not guarantee high interest and market interest rate changes can affect the prices. Because of these 2 reasons, beginners are not recommended to invest in bonds. It is important to understand coupon rates, yields, market prices, and interest rates to understand bonds before investing in them. 

Frequently Asked Questions

What is a bond ladder?
A strategy of holding bonds with different maturities to manage interest rate risk and maintain a steady income.

What is a bond fund?
A mutual fund or ETF that invests in multiple bonds, offering diversification and professional management.

What is duration, and why does it matter
Duration measures a bond’s sensitivity to interest rate changes. A Higher duration means bigger price swings for the same rate move.

What is convexit,y, and how is it different from duration
Convexity captures how duration changes as yields move. It refines price change estimates for large interest rate moves.

How do bond ETFs compare with buying individual bonds?s
Bond ETFs offer instant diversification and liquidity, but charge management fees and trade at market prices. Individual bonds give fixed maturity cash flows if held to maturity.y

What are credit default swaps, PS, and why do they matter for bond investors
CDS are insurance-like contracts against issuer default. Prices signal market views on credit risk and affect bond yields.

How do rating downgrades impact bond prices and yields
Downgrades raise perceived default risks, usually causing bond prices to fall and yields to rise. Impact size depends on liquidity and market sentiment.

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