Bonds offer Fixed Income to investors, and are relatively less risky
investment category as compared to other asset classes (viz. Equity,
Commodities, Alternative Investments etc). Bonds provide a
fixed-return to investor (similar to a Fixed-Deposit), but are
relevant for investors who wish to go for higher returns vs FD’s,
while bearing a little higher risk.
An allocation of your investments to Fixed Income Investments is
necessary for portfolio diversification, intended to minimize overall
risk of your portfolio.
A Bond is a fixed income instrument that
represents a loan given by an investor (bond holder) to a borrower
(bond issuer). Borrowers (Issuers) range from Central Government,
States, Public Sector Undertakings, Corporates, Municipal Corporations
etc., who want to raise funds. When you “buy a bond” (i.e: lend money
to the Issuer), the Issuer will pay you interest for the tenure they
borrow the Principal amount, and will return the Principal at the
maturity of the Bond.
Fixed income instrument play a crucial role in an investor's
portfolio. Owning bonds helps in diversifying a portfolio’s risk, as
changes in the bond prices are not correlated with changes in the
equity market. This helps in reduction of overall risk of the
Portfolio (Ex: Bond prices were not affected in Equity Market
correction in 2018, providing stability to overall Investment
Portfolios of investors).
It is important to note that Bond Prices are
affected by changes in Yields in Bond Markets, and Yields in Bond
Markets are in-turn dependent on Macro-economic variables. From a
retail investor’s perspective, who generally hold the Bonds till their
maturity, fluctuations in Bond prices have no practical impact on
their portfolio.
When investing in Bonds, it is very important to
understand the rating profile of the bond issuer, which can be gauged
from their Credit Ratings. Highest credit rating is AAA (least risky)
and lowest is D (Default category). The spectrum of ratings is as
follows: AAA, AA+, AA, AA-, A+, A, A-, BBB+ and so on till Category
D.Investors can understand the risk by going through the Rating
Rationales available in public domain, from prominent rating agencies
are CRISIL, ICRA, INDIA RATINGS, CARE etc.
How to Invest in Bonds?
Typically, there are two options
available to invest in bonds;
Option 1:
One can use Primary market route to invest in
Corporate Bonds by subscribing to Public Issuance (similar to Equity IPO).
Option 2:
Secondary market quotes are mainly available in
inter-bank market only, and access of inter-bank market is limited
to institutional players like banks, mutual fund, insurance
companies. However, bonds can be purchased in secondary market by
Individual investors via SEBI registered intermediaries like Tipsons.
Let’s look at an example of how investing in bonds works:
Example for Primary Market:
Let’s say Mr. Y invests Rs. 1,00,000 in
a 10-year bond that pays him a 12% fixed annual interest rate. This
means that Mr. Y will be paid Rs. 12,000 per year for 10 years until
he receives back his principal or Rs.1,00,000. (He will receive the
principal amount back on the “maturity date”).
Example for Secondary Market:
On 24-Apr-2019, Mr. Y wants to invest
Rs. 1, 00,000 in bond issued by Banks. He selects high coupon bond
issued by Karnataka Bank. Bond details are;
Bond Issue Date: 18-Feb-2019
Bond Maturity Date: 18-Feb-2029
Bond Face Value (Value of one
bond): Rs. 1, 00,000
Coupon Rate: 12.00% (Interest
payment on 18-Feb annually
till maturity date)
Scenario 1:
If current price of the
Karnataka Bank bond is 100.50 (Price represented in % terms of
face value) and current market yield is 11.88%.
Mr. Y has to pay Rs. 100,500 as
principal amount (1, 00,000 X 100.50%) plus accrued interest Rs.
2,137 (holding period interest) to the seller. Total amount
payable to seller is Rs. 1,02,637.00 (Principal value plus accrued
interest).
Scenario 2:
If current price of the
Karnataka Bank bond is 99.50 (Price represented in % terms of face
value) and current market yield is 12.06%.
Mr. Y has to pay Rs. 99,500 as
principal amount (1, 00,000 X 99.50%) plus accrued interest Rs.
2,137 (holding period interest) to the seller. Total amount
payable to seller is Rs. 1, 01,637.00 (Principal value plus
accrued interest).
Under Both Scenarios:
Mr. Y will get annual interest
payment of Rs. 12,000 every year on 18th February till
the maturity of the bond. On maturity Mr. Y will get back his
Principal (Rs.100,000) along with that year’s interest.
Accrued Interest Calculation:
No. of days = 24/April/2019 –
18/February/2019
= 65 days
Now, calculate interest on
Principal value:
= 1,00,000*12.00/100*65/365
= Rs. 2,137
You can
connect with
us to get latest bond offering and know more about investing in bond market.
You can contact us on
Phone
#: +91 79
66828174/5 or write us on
connect@tipsons.com
