Investing in bonds has its own advantages and its own audience. Many consider it as a conservative investment but time and again bonds have provided stability to the portfolio along with decent gains. In our previous post, we discussed about advantages of investing in bonds. Now let’s look at the different types of bonds and what makes them attractive to invest.
Technically, Bonds are borrowing contracts between the bond issuer and investor. The bond issuer promises to repay the amount borrowed from the investor along with the coupon rate mentioned on it at the end of the term. Hence, bonds are one of the safest instruments to invest in. Naturally, the gains from bonds are limited as compared to equity. But at hindsight, it offers significant stability to the portfolio. And the listed bonds can be traded at higher values on the exchange. Hence it offers somewhat flexibility to bondholders when compared with fixed deposits.
Popular Types of bonds in India:
There are many types of bonds to invest in. These are generally termed based on the characteristics of the bonds, like “Zero-Coupon Bonds”, “Corporate Bonds”, “Government Bonds”, “Non-Convertible Bonds”, “Convertible Bonds”, etc. However, some very popular bonds in India can be listed as follows:
Government Bonds / GOI Savings Bonds / RBI Bonds:
Government bonds are most popular bonds in India since these are considered as safest bonds.
In the current scenario in India, the Budget has laid many plans to revive the economy whereas, the economic growth is flat or negative. The available resources with the government are not sufficient to meet its budget proposals. In such scenarios the government can raise the loans in the form of “Public Borrowings” via issuing “Bonds”. In other words, by investing in bonds issued by the government, the public can help the government meet its infrastructure or other needs.
Government Bonds can be either Tax-Free or Taxable
Some people assume that all the government bonds are tax free bonds. But that is not the case. For eg:
Government came up with Floating Rate Savings Bonds 2020 for 7 years with Coupon rate of 7.15% in July 2020. These are taxable bonds and can be applied by Individuals and HUFs. NRIs are not eligible to invest in these bonds.
Tax free Bonds
Tax free bonds are those where the interest income from the bonds is tax free. These are issued by companies like REC, HUDCO, IIFCL, IREDA or NABARD etc. These bonds are very popular in India and are traded on the stock exchanges. Hence their traded values are higher / lower than the issue prices. This changes the effective yield of the bonds and an individual might earn lower than the coupon rate of the bonds. Hence it is advisable to carefully check the YTM while investing in bonds trading on exchanges. (To understand how the yield changes read investing in bonds).
As the name suggests, Corporate Bonds are bonds issued by the companies / corporates. It is an another instrument apart from Debentures, with which the corporates accept loand from Public. A question arises as to why do corporates issue bonds instead of borrowing from banks? The primary reason is for lower interest costs. Many times corporates issue bonds to raise operational capital. Hence, one of the important factors to look for in corporate bonds is “Credit Rating”. The credit ratings will ensure about reasonable safety of the bonds.
Capital Gain Bonds
Capital Gain bonds or 54EC Bonds are the bonds referred under sec 54EC of the Income Tax Act. These bonds are the best bonds to invest in if you want to save tax on your Long term Capital Gains.
An individual can invest in these bonds on incurring long term capital gains from sale of a property, and avail the tax exemptions. The maximum limit for investing in these bonds is Rs 50 lacs.
Sovereign Gold Bonds
Sovereign Gold Bonds or SGB are very popular in India. They are nothing but bonds denominated in grams of Gold. So this is the perfect substitute to holding of physical gold. These bonds are issued by RBI on behalf of the government. The rate of interest on these bonds will be very low say 2.5%. Since the bonds are denominated in grams of Gold, on redemption of the bonds, the bondholder will get the grams invested in at the average of closing price of gold of 999 purity.