A bond is a fixed-income instrument that represents a loan made by an investor to a borrower, typically a government, municipal body, or company. When you buy a bond, you are lending money to the issuer in exchange for periodic interest payments and the return of the principal amount at maturity.
This content is for information purposes only and should not be treated as investment advice. Investors are advised to consult an independent financial advisor before making any investment decisions.
What is a bond and how does it work?
When a government or company needs to raise capital, it can issue bonds to investors instead of, or alongside, raising funds through equity. By purchasing a bond, an investor essentially lends money to the issuer. In return, the issuer agrees to pay periodic interest, known as the coupon, and to repay the original amount, known as the principal, on a specified maturity date.
Bonds are regulated in India under SEBI's framework for debt securities, and issuers range from the central and state governments to public sector undertakings and private companies. Bonds are part of the broader fixed-income category, and investors who prefer a managed approach to debt instruments can explore this through Chola Securities' guide to debt funds.
How do bonds generate returns?
Bonds generate returns for investors primarily in two ways. The first is through coupon payments, which are periodic interest payments made by the issuer based on the bond's coupon rate and face value. These payments may be made annually, semi-annually, or on another schedule defined at issuance.
The second is through capital appreciation if the bond is sold before maturity at a price higher than the amount paid. Bond prices in the secondary market fluctuate based on prevailing interest rates, the issuer's credit profile, and overall demand. When interest rates rise, existing bond prices with lower coupon rates typically fall, and when interest rates fall, existing bond prices typically rise.
Some bonds, known as zero-coupon bonds, do not pay periodic interest at all. Instead, they are issued at a discount to their face value, and the investor's return comes from the difference between the purchase price and the amount received at maturity.
What is the difference between a bond and a stock?
When you buy a stock, you become a part-owner of the company, with returns linked to the company's performance and subject to market price movements. When you buy a bond, you become a lender to the issuer, with a defined repayment structure and a fixed or predetermined interest rate.
| Parameter |
Bonds |
Stocks |
| Relationship to issuer | Lender (creditor) | Owner (shareholder) |
| Returns | Coupon payments and principal repayment | Dividends and capital appreciation |
| Risk | Generally lower, varies by issuer credit rating | Generally higher, tied to market performance |
| Priority in repayment | Bondholders are paid before shareholders in case of liquidation | Shareholders are paid last |
What is the face value of a bond?
The face value, also called par value, is the amount printed on the bond at the time of issuance. It represents the principal amount the issuer agrees to repay the investor at maturity and is also the amount on which coupon payments are calculated.
For example, if a bond has a face value of Rs 1,000 and a coupon rate of 7 per cent, the bondholder receives Rs 70 per year in interest, regardless of whether the bond is currently trading above or below its face value in the secondary market. SEBI reduced the minimum face value for privately placed debt securities from Rs 1 lakh to Rs 10,000 in July 2024, making bonds more accessible to retail investors. You can refer to SEBI's official circular on this reduction for further details.
What are coupon payments?
Coupon payments are the periodic interest payments made by a bond issuer to the bondholder. The coupon rate is expressed as a percentage of the bond's face value and is typically fixed at issuance, remaining constant for the life of the bond regardless of market interest rate movements.
For example, a bond with a face value of Rs 1,000 and a coupon rate of 6 per cent will pay Rs 60 per year in interest, whether the bond's market price rises or falls. Coupon payments can be made annually, semi-annually, or quarterly, depending on the terms set by the issuer.
Are bonds safer than stocks?
Bonds are generally considered lower-risk than stocks, but they are not risk-free. Bonds issued by the government carry minimal credit risk since repayment is backed by a sovereign guarantee. Corporate bonds, on the other hand, carry credit risk, which depends on the financial strength of the issuing company.
Credit rating agencies registered with SEBI, such as CRISIL, ICRA, and CARE, assess and assign ratings to corporate bonds based on the issuer's ability to meet repayment obligations. As per SEBI regulations, all publicly issued corporate bonds must be rated by at least one registered credit rating agency. Bonds rated BBB- and above are generally considered investment grade, while bonds rated below this threshold carry higher default risk.
Bond prices are also subject to interest rate risk, meaning their market value can fluctuate based on changes in prevailing interest rates, even though the coupon payments themselves remain fixed.
How are bonds traded?
Bonds can be bought either at the time of issuance, known as the primary market, or subsequently in the secondary market through a stock exchange. In India, bonds are listed and traded on exchanges such as the NSE and BSE through their dedicated debt segments.
To trade bonds in the secondary market, an investor needs a demat and trading account with a SEBI-registered broker. Bond prices in the secondary market are influenced by factors such as prevailing interest rates, the remaining time to maturity, and the credit rating of the issuer.
Final thoughts
A bond is a fixed-income instrument that allows investors to lend money to a government or company in exchange for periodic interest and the return of principal at maturity. Understanding concepts such as face value, coupon rate, and credit ratings helps investors evaluate whether a particular bond fits their risk appetite and income goals.
While bonds are generally considered lower-risk than stocks, they are not entirely risk-free, and factors such as interest rate movements and issuer creditworthiness should be carefully considered before investing.
To get started with trading and investing, you can open your account through the Chola Securities KYC portal.
Disclaimer: Cholamandalam Securities Limited (CSEC) is a SEBI-registered stockbroker and depository participant. CSEC does not provide investment advisory services. Investors are advised to consult an independent financial advisor before taking any investment decisions.