Bonds are a mechanism through which Government and Corporate raise money from the public for long term projects. In simple words, bonds are loans given by investors to a company or a government.
Why do they raise money from public?
Because if they approach the bank, they would have to pay higher rate of interest.
Why should we invest in them?
Because we get higher interest rate compared to bank with slightly more risk and in some cases we even get tax exemption in bonds.
In simple words, bonds are loan given by investors to a company or a government. By issuing bonds, corporate or government borrows money from investors who in return are paid interest on the money they have loaned. This money is used to fund new projects or ongoing expenses. Many Investors use bonds to preserve the income they have and generate some additional income because they have less risk compared to equity. Earlier Investment in Bonds market was restricted to only banks and large financial and minimum amount was 5 Crore. But now the scenario has changed thanks to NSE and RBI, retail investors can also invest and the minimum amount which is 10 thousand but still price is decided by big financial institutes. How? Hold your curiosity it will explain that in next couple of paragraphs.
As mentioned above there are 2 types of bonds, government and corporate bonds. In this chapter well focus more on government bonds. As the name suggests government bonds are issued by RBI on behalf of government so that it can fund its expenses or new projects. When we need loan we go to our bank for the same. This is what government does, it goes to RBI for loan and RBI in turns asks public for money. If the money is to be returned within 1 year (maturity time 1 year) we call it Treasury Bill or T-Bill and if more than 1 year then we call it Government Bond or Government Securities or G-Sec.
T-Bills are issued on discount and mature at Par. There are 3 types of T-Bills available 91 days, 182 days and 364 days maturity period. Now suppose we invest in 100 rupee 91 days T-Bill. The issue price of that bill won’t be 100 it would be less than that and after 91 days we will get par amount which in this case in 100 rupee.
Calculating T-Bill Yield
Suppose we invest 95 rupee in a T-Bill. Par value: 100 Duration: 91 days. Now we earn 5 rupee on 95 amount invested so our rate of return would be 5.26% (5 divide by 95). But we have earned this in 91 days so per annum rate would be 21.09%
21.09% = ((5/95)*(365/91))*100
Government Bond/ Government Securities/G-Sec
Bonds are issued at par and pay interest semi annually and that is how they are different from T-Bills. In Bonds we have option to let our interest accumulate (Cumulative bonds) or withdraw every time it is due (Non-Cumulative bonds). Calculation of Yield Rate of government bonds will be done in the last chapter of this module.
Naming of Bonds
A typical Government Bonds looks like this “750GS2034A”. Let’s break this down
Features of Government Bonds
Because these bonds are issued by a government they are considered less risky.
Some bonds also help investors save tax up to a certain limits. We can save up to 1,50,000 under section 80C by investing in government bonds.
Most of the government’s bonds can be bought and sold in the open market hence provide liquidity. But there are some bonds which cannot be sold in the open market and if we invest in those bonds we have to keep our amount till certain lock-in period and if we withdraw before that, we have to pay some penalty.
Fixed Interest Rate
Also called coupon rates, these rates are fixed and will not change till the maturity of the bonds. This is both good and bad. If the market interest rate increases compared to our bond interest rate, we are actually losing money and if the market rate reduces, we will gain a lot of money.
Gains from Bonds are subject to indexation so we can use the benefits of the same and pay less tax.
Most of the bonds can also be used as collateral for taking loans from banks and other financial institutions.
Pricing and How can we invest in these Bonds?
RBI uses a bidding process to price the bonds. It accepts bids from all the participants which in this case would be big banks and financial institutions and small retail investors. We have to pay a slightly higher amount while placing our bid and then RBI takes an average of all these amounts and decides the price of the bond. The difference if any between the amounts paid by us and the weighted amount is credited back to our account. Because money is invested by big players so the price comes near to their bid amount only.
We can go to any of the SBI or its associate banks to invest in bonds. Other than SBI, all nationalized banks and some private sector banks like ICICI and HDFC can become the mediator for us. The minimum order amount is 10 thousand and it’s multiple and upper caps of 2 crores. We can place the order when new bonds or T-Bills are available (like IPO). The whole schedule of the upcoming issue of T-Bills and Government Bonds is available on the RBI website.
Once these bonds are issued to banks and financial institutions, trading in dematerialized form is done on automated order-driven systems of BSE, NSE and over the counter exchange of India.
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