Meaning of Bond
A bond refers to the instrument which obligates the issuer to pay pre-defined interest to the buyer. The face value of the bond is its par value and it is mentioned on the bond document. Bonds are generally issued in denominations of 1000, 2000, and so forth. The specific rate of interest payable on a bond is called its Coupon rate. Mostly the interest payments of bonds are fixed till the maturity period. The interest payment on a bond may be quarterly, semi-annually or annually. The value of the bond is repaid at the end of maturity period.
Features of Bond
- Par Value: Par value is also known as Face value. Par value is used for specifying the value of bonds in balance sheet. A bond may be issued at a price higher or lower than the par value. Par value is payable at the expiry of bond tenure.
- Coupon Rate: Coupon rate is also known as coupon interest rate, it is the interest rate payable on the par value of a bond. It is specified in relation to the par value of the bond. Interest may be payable quarterly,semi-annually or annually. Further, a bond may be a floating rate bond where interest rate fluctuates in relation to general interest rate. A zero coupon bond is one which is issued below its par value and does not offer any interest.
- Maturity Date: It is the date when par value of a bond is repayable. This is specified according to the terms of issue.
- Call Provision: Some bonds come with call provision where the issuer may choose to redeem the bond before its original maturity date. However, the issuer needs to fulfill specified terms and conditions for this purpose. This right is generally exercised in the case of fall in general interest rate. Thus,these bonds have early provision of redeeming the bonds before its maturity date. Therefore it is known as Callable bonds.
Types of Bonds
1. Premium Bonds: A premium bonds are sold at a price higher than its par value. Ex: If a bond with face value of Rs/-100 is sold at Rs/-150 in the market, it will be termed as a premium bond. The premium in this case would be Rs/-50.
2. Convertible Bonds: These bonds bestow a right on the holders to convert them into equities, as specified by the terms of the issue. The ratio of conversion is generally pre-determined. Once converted, these bonds acquire the characteristics of equity shares. Here, the process of conversion from bond to equity of the same company on a pre-determined ratio is termed as Conversion Ratio.
3. Discount Bonds: Opposite of premium bonds, these bonds are sold at a price lower than their face value. A bond with face value of Rs/-100, sold at Rs/-60 will be called a discount bond where Rs/- 40 will be the discount.
4. Mortgage Bonds: These bonds are backed by assets such as machinery or real estate. Due to this, these bonds have low risk profile.
5. High Yield Bonds: These are also known as junk bonds, these bonds come with higher interest rate to compensate for their high credit risk. These bonds are deemed speculative by grading agencies and are not considered investment grade. This bond is not worth to make investments because the money gets blocked for pre-determined period and would not increase more.
6. Fixed Income Bonds: These bonds generate fixed amount of income for their holders. The interest rate is lower as risk associated with these bonds is less.
7. Government Bonds: These bonds are generally issued by the government to their residents. These bonds are considered to have lowest default risk as the government generally does not go bankrupt. Consequently, the interest rate payable on such bonds is also lower than other debt instruments. It gives a fixed yield to the holder of this bond.
8. Corporate Bonds: These bonds are issued by companies are known as corporate bonds. In India, such instruments are generally called debentures, whether these are secured or unsecured. Internationally, secured corporate debt instrument is referred to as a ‘corporate bond’ While an unsecured instrument is called a ‘corporate debentures’.
9. Municipal Bonds: These bonds are issued by city or state corporations. These may be generally purpose bonds or specific purpose, where the funds are raised for particular projects.