A bond is a form of loan taken by a company from investors who purchase its bonds. In exchange, they pay and interest as a percentage of the face value.
There are two types of bonds.
- Secured bond
A secured bond pledges some specific assets to bondholders in a situation where the company isn’t able to repay its obligation. They are backed by collateral.
- Unsecured bonds
Bonds that do not have the backing of any collateral are known as unsecured bonds or debentures. Only the issuing company guarantees the principal and interest.
Bonds, other than tax free bonds, are taxable as per the tax status of the bondholder. Most corporate bonds are taxable. However, there are some municipal and Government bonds with tax exemption where capital gains are not taxed, under Section 10, Income Tax Act of India, 1961.
- (i) Income Tax: Interest on bonds is taxable under the Income-Tax Act, 1961, based on the tax slab of the individual.
Sale consideration of the bond is referred to as capital gains. If listed bonds are held for more than 12 months and unlisted bonds for more than 36 months, the capital gain is considered long-term capital gain (LTCG) and taxed at 20% plus surcharge and cess. Otherwise, short-term capital gain (STCG) is taxed as per slab rate from 5% – 30%.
- (ii) Wealth Tax: Bonds are exempted from wealth tax under the Wealth- Tax Act, 1957.
Your Financial Goals, Time Horizon, and Risk Profile are the main determinants that help you select the right bond for your investment portfolio. If your time horizon allows, you can invest in tax-free bonds like municipal and Government bonds to save taxes.
Answer these three questions while choosing a bond:
- Do you want regular income or investing for long-term growth?
- How long do you intend to keep your funds invested?
- How comfortable are you with risk?
Bonds have a rating outlining their ability to pay principal and interest. It’s better to consult investment experts besides checking ratings to determine the worthiness of a bond.
Bond investors should know that the market interest rates and prices of fixed-rate bonds generally move in different directions. With an increase in market interest rates, prices of fixed-rate bonds decrease. It is called interest rate risk.
- Interest Rate Cycle
- Change in the Credit rating of securities (Upgrade/Downgrade)
- Liquidity of bond
- Tenure of bond
- If a bond offers a 5% coupon rate (interest rate). Market interest rates decrease to 4%. You will still receive a 5% coupon rate, provided you hold the bond until maturity:
- If you sell the bond before its maturity, its price will be higher than it was in the previous year. With the increased bond price, the yield will be decreased for the bond buyer at the new, i.e., higher price.
A bond’s maturity is the date to calculate and repay the bond’s face value to the investor, like after 6 months, 5 years, etc. The maturity period also affects interest rate risk. A bond with a longer maturity period generally has a higher interest rate risk because the changing interest rates can negatively affect the bond’s price.
- Longer maturity means higher interest rate risk
- Shorter maturity means lower interest rate risk
There is no maximum limit for bond investments. The issuer can define a low amount and its multiples thereof for bond investment. You can find bonds with a face value of as low as Rs.1000 and invest in its multiples.
You can hold bonds in the demat account only. No issuer provides bonds in paper format. You need to fill in your DP ID and DP Client ID in the application form to buy bonds.
SGBs are Government Securities (G-Sec). RBI (Reserve Bank of India) issues these bonds on behalf of the Indian Government. SGBs are substitutes of gold in physical form to avoid issues like purity, valuation, warehousing and safe custody. The denominating unit is grams of gold.
Zero-coupon bonds do not possess coupons for the entire tenor, and the maturity date is fixed. The whole face value is paid on maturity. These bonds are issued at a huge discount.
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