How bonds work?
When the Government, Banks or a corporate entity wants to raise money, they borrow a sum from investors and in return, agree to repay the amount plus interest on a periodic basis. This agreement between the issuer (borrower) and investor (lender) is commonly known as ‘bonds’. This interest rate is called as ‘coupon rate’ and the pre-defined time is called as ‘maturity’.
Bonds are typically considered as the safe investment avenue as they can offset exposure to equity market volatility and offer stable income stream/cash flow. Today, there are various types of bonds available in the market and each one of them suitable for different types of investors and goals.
Types of Bonds
Capital Gains/ 54EC bonds
Capital gains bonds can help investors save long term capital gains tax. Their AAA rating and the lock-in period of 5 years are some of the other features of these bonds. The maximum amount one can invest in these bonds is up to Rs. 50 lakh and the tax benefit is available u/s 54EC of Income Tax act.
Issued by the state and central government of India, Government Bonds offer a combination of assured fixed returns with complete safety of your principal amount. These is typically a long term investment option and interest rates offered are subject to change due to external factors such as inflation, investor sentiments or change in regulatory policies.
Fixed maturity bonds
These bonds carry consistent coupon rates throughout the tenure. Investors know the exact amount they will receive at the end of tenure, irrespective of market fluctuations.
Perpetual bonds are fixed-security investment options without any maturity period. Issuers pay interest for perpetuity (forever) and the principal amount is redeemable through either the call or put option announce at the time of issuance of these bonds. These Bonds are traded in secondary markets like how it is in case of Equities. The coupon rate of interest too is fixed at the time of issuance along with the interest payment dates.