Fixed income avenues need not always be restricted to fixed deposits – look at listed bonds and debentures.
Bond are a fixed income instrument that is simply a loan made by an investor to a borrower who in this case is a corporate entity. You can even look at investing in Sovereign Gold Bonds backed by the Government that will also make sense if you want to add gold to your portfolio.
Bond Market
The financial market is divided into the money market (that deals with treasury bills, certificate of deposits, commercial papers, and Repo) and the capital market (that has a primary and secondary market). The primary market deals with public issue, rights issue, bonus issue and private placement and the secondary market is the stock market. Corporates can raise money through the capital market by issuing bonds. When the corporate does this for the first time, it is called primary market and is usually done through private placement. All listed bonds are traded in the secondary market and are used by a company to borrow money on defined terms with the investor. So why invest in bonds? The investors benefit by investing in fixed income securities, as they preserve and increase their invested capital and ensure they receive regular interest income.
Fixed Deposit vs. Bonds
A question that comes to mind with bonds is how they compare with fixed deposits (FDs). Most bonds are secured in nature as it is backed by assets. FDs are unsecured and bank FDs are insured up to Rs. five lakhs (capital and interest per depositor). Bonds can be liquidated as they are tradable on exchanges, whereas fixed deposits can be withdrawn prematurely but there will be a penalty in the form of reduced interest rates. Zafar Imam, CEO, FinShell says, “both Bonds and debentures offer a fixed rate of interest. They are less risky than investments in Mutual fund, Gold, and Equity shares. For those who want to low risk with stable returns Bonds and Debentures can be a good option. Usually, the return in these instruments is higher than the saving account and fixed deposit.”
Yield & Rating
Understanding yield which is the effective rate of interest that is paid on the bond is an important aspect of bonds. There are many kinds of yield depending on the investment scenario and the characteristic of the investment. Yield to Maturity (YTM) is the most popular measure of yield in the debt market. It is the percentage rate of return paid on a bond or other fixed income security, if you buy and hold the security till its maturity date. Yield to Call (YTC) is also a measure of the yield in the debt markets and is the percentage of total return paid on a bond or other fixed income security if you buy and hold the security till its call date. It usually comes into play in case of perpetual papers. Current yield is the coupon divided by the market price and gives a fair approximation of the present yield. Triple A (AAA) is the highest degree of safety regarding timely service of financial obligations and has the lowest credit risk. Double A (AA) gives high degree of safety and very low credit risk. A rating of A gives adequate degree of safety and signifies low credit risk. The other ratings are BBB BB, B, C and D.
Risk Factor
Interest rate risk can be defined as the risk emerging from an adverse change in the interest rate prevalent in the market to affect the yield on the existing instruments. Reinvestment rate risk is another risk which the probability of a fall in the interest rate resulting in a lack of options to invest the interest received at regular intervals at higher comparable rates in the market. “If you are risk-averse and looking for regular interest income and interest rate better than bank FDs, within the fixed-income investment space, then Bonds and Debentures could be an ideal alternative. The principal amount you invest is relatively safer when compared to other market linked products. Additionally, you can earn attractive and competitive yield (based on the coupon rate) on the amount invested, till the maturity date. On maturity, you will get back the principal amount invested,” says a spokesperson from Geojit Financial Services Ltd.
Taxation
The interest earned on fixed income investments like bonds and debentures subject to income tax. The interest earned from the bonds will be taxed at the slab rate that you fall under as per your overall income. For tax-free bonds, interest earned is completely tax free. In case of any appreciation of the value of the listed bond at the time of the sale on the secondary market or during redemption, short term capital gains tax (if held less than one year) or long-term capital gains tax (if held over one year) will be applicable. While short term gains are taxed as per the tax labs of the investor, long term gains are taxed at a flat rate of 10%, without indexation for listed bonds.
Sovereign Gold Bonds
These are issued in tranches by the Reserve Bank of India on behalf of the Government of India and are open for investment over a specific period. These bonds are like a substitute for holding physical gold and are denominated in grams of gold. A discount of Rs 50 per gram is offered when the bond is purchased digitally. You can buy them through banks, stock exchanges and financial brokers.
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