You may want regular interest payments to help with expenses or an investment that matures around the time you need your money. Different types of bonds offer different ways to meet these needs.
Their labels describe different features. “Government” identifies the borrower, “fixed-rate” explains the interest calculation, and “secured” describes the assets backing the borrowing. One bond can carry all three descriptions.
Understanding bonds and their types helps you compare the payments, repayment terms and purchase price with your financial plans.
Table of Contents
What are bonds?
A bond is a debt instrument through which a government, company or other issuer borrows money from investors. A conventional bond specifies interest payments and principal repayment under its terms.
Buying a bond makes you a lender to the issuer, while buying company shares makes you a part-owner of the business. Bonds are part of the broader category of fixed income securities, although their interest payments are not always fixed.
Key Takeaways
- Bonds represent borrowing, with interest and repayment arrangements specified in their terms.
- Bond categories overlap because issuer, payment structure, security and special features describe different characteristics.
- A bond’s coupon rate differs from its yield, which also depends on the purchase price.
- Credit ratings assess repayment risk, while interest-rate changes, inflation and liquidity require separate consideration.
- Compare maturity, payment frequency, exit conditions, costs and taxes before choosing a bond.
Features of bonds
These details help you understand how a bond works:
- Issuer: The entity that borrows your money and is responsible for the payments.
- Face value: The stated principal amount, which can differ from your purchase price.
- Coupon rate: The specified interest rate, generally applied to face value for a conventional fixed-rate bond.
- Payment frequency: How often interest is paid, if the bond makes periodic payments.
- Maturity: The scheduled repayment date, where the bond has a fixed maturity.
- Credit rating: A rating agency’s opinion about timely and complete repayment.
- Security: Whether specified assets are pledged as collateral.
- Exit provisions: The terms governing an early sale or redemption, where available.
For a conventional fixed-rate bond, the coupon rate stays unchanged even when its market price moves. The price you pay therefore affects your investment yield.
Types of bonds based on the issuer
The issuer is a useful starting point because it identifies who is responsible for the payments.
Central government bonds
The Government of India issues dated government securities with fixed or floating coupons. The Reserve Bank of India, or RBI, describes domestic government securities as carrying no credit risk. Their market prices can still change before maturity.
Treasury bills also represent government borrowing, but they are short-term money market instruments issued at a discount and redeemed at face value, without regular coupon payments.
State government bonds
State governments borrow through State Development Loans, or SDLs. These dated securities have specified interest and repayment arrangements. Read about government bonds for more context on central and state government borrowing.
Corporate bonds
Companies issue corporate bonds to finance their activities. Compare the issuer’s repayment capacity, the offered yield and the bond’s terms.
Different bonds from the same company can have different collateral or repayment priority, so the company name alone does not explain the investment.
PSU bonds
Public sector undertakings, or PSUs, issue bonds that are obligations of the issuing entity. Government ownership does not automatically give every issue a government guarantee; check the specific bond documents.
Municipal bonds
Municipal bodies issue bonds to fund local requirements, including infrastructure. Review the repayment arrangements and financial disclosures in the issue documents. The Securities and Exchange Board of India, or SEBI, maintains an official record of municipal bond issuances.
Types of bonds based on interest payments
The payment structure determines whether you receive regular interest, changing payments or a return concentrated at maturity.
Fixed-rate bonds
A fixed-rate bond’s coupon rate stays unchanged during its stated term. For a conventional bond with unchanged principal, this makes scheduled interest amounts easier to plan around.
Floating-rate bonds
A floating-rate bond resets its coupon at specified intervals using a benchmark, sometimes with an additional spread. Payments can rise or fall as the benchmark changes. Floating rates do not automatically track inflation.
Zero-coupon bonds
Zero-coupon bonds make no periodic coupon payments. They are generally issued at a discount and redeemed at face value, with the difference providing the contractual return if repayment happens as agreed. They suit a different payment need from bonds bought for regular income.
Secured and unsecured bonds
Secured bonds pledge specified assets as collateral, while unsecured bonds have no such collateral. Both depend on the issuer meeting its obligations. For secured bonds, consider the assets and the bondholder’s legal claim over them. Repayment priority also matters: senior debt generally ranks ahead of subordinated debt. Collateral can support recovery if payments are missed, although the amount recovered depends on asset values and the recovery process.
Types of bonds with special features
Some provisions change when repayment happens or what the investor receives:
| Type | Main feature | What to check |
| Callable bonds | The issuer can redeem the bond early | Permitted call dates, repayment price and the effect on expected income |
| Puttable bonds | The investor can seek early redemption | Dates and conditions for exercising the right |
| Convertible bonds | Can convert into another security, usually shares | Who controls conversion, its timing and the conversion formula |
| Non-convertible debentures, or NCDs | Do not convert into equity | Payment terms, security and repayment priority |
| Perpetual bonds | Have no fixed maturity date | Payment conditions and any call provisions |
A call date is an opportunity for the issuer to redeem the bond under its terms, rather than a promised repayment date. Convertible bonds also change the nature of your investment when they convert into shares.
Some perpetual bank bonds, such as Additional Tier 1 bonds, have loss-absorption features that can reduce principal under specified conditions. These structures need separate assessment from ordinary bonds.
Other bond categories investors may encounter
These labels describe additional features and can overlap with the categories above.
Inflation-indexed bonds
Inflation-indexed bonds link principal or interest calculations to a specified inflation measure. India has used different structures historically, so check current official issue announcements for investment availability. Read about inflation-indexed bonds to understand their adjustment mechanisms.
Green bonds
Green bonds raise money for eligible environmental projects or activities. The label describes the use of proceeds, rather than the issuer’s repayment strength.
Sovereign Gold Bonds
Sovereign Gold Bonds are government securities denominated in grams of gold, with gold-linked redemption values and interest arrangements. Before buying, check current issuance notices or the availability of an outstanding listed security.
Tax-free bonds
Certain notified bonds offer an exemption for interest income, subject to applicable conditions. Gains from selling them require separate assessment. Tax-free interest is also different from a tax-saving benefit associated with investing in a qualifying bond.
The tax information in this article is based on prevailing laws at the time of publishing the article and is subject to change. Please consult a tax professional or refer to the latest regulations for up-to-date information.
How are bonds rated?
A credit rating expresses a rating agency’s opinion about timely and complete repayment. India’s standardised long-term rating categories include:
| Rating | Broad meaning |
| AAA | Highest degree of safety regarding timely payment, with the lowest credit risk |
| AA, A and BBB | Progressively lower assessments of repayment safety |
| BB, B and C | Progressively higher assessments of default risk |
| D | In default or expected to default soon |
Ratings can change, so read the latest rating and its supporting explanation. The Securities and Exchange Board of India, or SEBI, regulates relevant credit rating agencies but does not assign their ratings. Ratings also do not measure every risk, including the ease of selling a bond or changes in its market price.
What is yield to maturity in bonds?
Yield to maturity, or YTM, brings together the price you pay for a bond and its remaining interest and repayment amounts. It helps you compare bonds whose prices and coupon rates differ. Three measures are useful here:
- Coupon rate: The interest rate specified in the bond’s terms.
- Current yield: Annual coupon income divided by the current market price, excluding gains or losses at maturity.
- Yield to maturity, or YTM: The annualised rate implied by the purchase price and remaining contractual payments through maturity.
For a conventional fixed-rate bond repaid at face value, the purchase price affects YTM:
- Buying below face value generally produces a YTM above the coupon rate.
- Buying at face value generally produces a YTM matching the coupon rate.
- Buying above face value generally produces a YTM below the coupon rate.
Achieving the corresponding compounded return depends on receiving payments as expected and reinvesting coupons at that rate. Taxes, costs, early redemption or an early sale can change what you earn.
Advantages of investing in bonds
Depending on the bond you choose, the advantages include:
- Scheduled income: Coupon-paying bonds provide payment dates that help with expense planning.
- A repayment timeline: A stated maturity helps you match an investment with a future need, provided repayment happens as agreed.
- Diversification: Bonds add another source of income and investment exposure alongside shares and other assets.
- Payment choices: Regular coupons, floating payments and returns concentrated at maturity serve different income needs.
The benefit to your portfolio depends on the bonds selected and your existing investments.
Limitations and risks of bonds
These considerations help you assess how a bond fits your plans:
- Credit risk: The issuer may delay or miss interest or principal payments.
- Interest-rate risk: A fixed-rate bond’s market price generally falls when market yields rise, affecting the amount available from an early sale.
- Inflation risk: Fixed payments may buy less as prices rise.
- Liquidity risk: Finding a buyer at an acceptable price can take time.
- Reinvestment risk: Interest or repayment proceeds may need to be reinvested at lower rates.
- Call risk: Early redemption can shorten the interest-payment period you expected.
Modified duration helps you compare sensitivity to yield changes. Higher modified duration generally means a larger price movement for the same small change in yield.
Bonds vs fixed deposits vs debt mutual funds
The main differences concern ownership, returns and access to your money:
| Aspect | Direct bonds | Fixed deposits | Debt mutual funds |
| Investment relationship | You hold the issuer’s debt security | You place a deposit with the institution | You own units in a managed portfolio |
| Return | Depends on payments, purchase price and repayment | Follows the agreed deposit terms | Depends on portfolio performance and expenses |
| Early exit | Depends on buyers or redemption provisions; prices can change | Follows withdrawal rules and any applicable penalty | Follows redemption terms; unit values fluctuate |
| Diversification | Requires selecting multiple holdings | Requires deposits across institutions | Depends on the scheme’s portfolio |
Debt mutual funds do not offer assured returns. Their values reflect their holdings and market conditions. Read about bonds, fixed deposits and debt mutual funds for a fuller comparison.
Returns on fixed deposits/savings accounts are fixed, however, returns on mutual funds are subject to market risks.
How to invest in bonds in India
The route depends on the instrument you want to buy.
Government securities through RBI Retail Direct
Eligible individuals can open a Retail Direct Gilt account with RBI to access government-security auctions and secondary-market transactions.
Corporate bonds
Investors can access eligible corporate bonds through public issues, brokers and permitted trading platforms. For an online bond platform, verify its registration using the exchange lists linked by SEBI.
Savings bonds
Savings bonds may use separate subscription and holding arrangements. Floating Rate Savings Bonds, 2020 (Taxable), use a Bond Ledger Account and are not tradable in the secondary market.
What to check before investing in bonds
Start with when you need the money and whether you want regular income. Then review:
- Repayment capacity: The issuer’s finances and latest rating explanation.
- Payment terms: Interest calculation, payment dates and maturity.
- Total cost: Purchase price, accrued interest where applicable and fees.
- Exit arrangements: Trading activity, redemption rights and restrictions.
- Special features: Collateral, repayment priority, conversion and call provisions.
- Taxes: Treatment of interest and any sale or redemption.
For traded coupon-paying bonds, the amount payable can include accrued interest in addition to the quoted price.
Conclusion
Understanding the features of a bond and types of bond available helps you compare investment choices. Government bonds, corporate bonds and different payment structures can serve different financial needs. Match the bond’s income and maturity with your plans, then assess its yield, repayment strength, liquidity and costs to make an informed choice.
FAQs
Which is the safest type of bond?
For repayment risk in the domestic market, Government of India securities carry practically no default risk. However, their prices can change before maturity, and inflation affects purchasing power. The suitable choice also depends on when you need your money.
What is the riskiest type of bond?
There is no single answer for every kind of risk. Lower-rated corporate bonds generally carry greater repayment risk, while some perpetual and subordinated structures have additional features affecting payments or recovery. Compare the individual bond rather than relying only on its category.
Are bond returns guaranteed?
A stated coupon sets out a payment obligation; it does not guarantee every investor’s overall return. Your result also depends on repayment, purchase price, costs, reinvestment and whether you sell before maturity. Any explicit guarantee should be checked for its scope and conditions.
Does every bond require a demat account?
No. The holding arrangement depends on the instrument and investment route. RBI Retail Direct uses a Retail Direct Gilt account, while Floating Rate Savings Bonds use a Bond Ledger Account. Check the requirements for the particular security.
Does exchange listing make a bond easy to sell?
Listing provides a trading venue, but the availability of buyers and the offered price still matter. Check trading activity and available quotes if an early exit is important to you.
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