Things to know before investing in bonds

Here's what you need to consider:

1. Secured/Unsecured

Bonds are often thought of as a safe investment. But there are actually two kinds of bonds - secured and unsecured. 

Secured bonds are a type of debt security in which the bond issuer has pledged collateral to secure the bond. It can be in the form of cash, property, or other assets. The purpose of securing a bond is to protect the investor from default.

An unsecured bond is a debt security issued by a company without the backing of any collateral. This means that if the issuer defaults on the bond, investors will not have any assets to claim. Unsecured bonds are also called debentures.

2. Maturity

A bond’s maturity is the time length until the bond expires and must be repaid in full. The maturity date is typically several years in the future. 

Short-term bonds are the bonds with maturities of one to five years while long-term bond maturity varies across tenure of more than five to twenty years.

Perpetual Bonds are bonds which do not have a maturity date, it means that in theory, these are the kind of bonds that continues to pay interest. A business or bank issues perpetual bonds with the objective of raising capital amounts. It has no maturity date, so it can be treated as equity.

So, it is important to understand the maturity date and what it means for your investment. 

3. Liquidity Preference

This refers to how easily the bond can be sold for cash. For example, government bonds are typically more liquid than corporate bonds.

It's important to research the liquidity preference of the specific bonds you are interested in.

You should also keep in mind that even highly liquid bonds may take some time to sell, so you may not be able to access your cash right away if you need it.

An appropriate financial institution should be used when opening a saved fixed deposit. Treasury bonds are traded on the open market, so they are more liquid as a type of asset. However, economic moves can affect the price of bonds. Therefore, liquidity comes with a degree of market volatility.

Overall, understanding the liquidity preference can help you make more informed decisions. 

What are Bonds: Different Types and The Benefits of Investing in Bonds

4. Coupon Rate

Bonds are a category of debt security in which the buyer owes a debt to the holder and is obliged to repay and interest in the fixed intervals. The coupon rate can be explained as the annual interest rate paid by the issuer to the holder. It is important to know the coupon rate as it will affect the return you receive on your investment.

The coupon rate on offer is based on multiple factors, including the creditworthiness of the issuer, the market conditions at the time of issue, and the maturity date of the bond. Higher-rated bonds will typically have lower coupon rates than lower-rated bonds. Market conditions can also impact coupon rates; for example, if interest rates are rising, issuers may offer higher coupon rates to attract buyers.

5. Tax Factor

The interest you earn on most bonds is subject to income tax but there are some exceptions. Such as, Public Sector Undertakings (PSU) bonds are typically exempt from federal taxes.

Bonds in India are taxed based on a number of factors, including the type of bond, the tenure of the bond, and the interest rate.

The type of bond plays an essential role determining the tax rate. For example, government bonds are taxed at a lower rate than corporate bonds. Government bonds are less risky as compared to corporate bonds. The tenure of the bond is another important factor. Short-term bonds are taxed at a higher rate than long-term bonds. This is because short-term bonds include more risk than long-term bonds. The interest rate similarly plays an important role.  Bonds with higher interest rates are taxed at a higher rate than bonds with lower interest rates.

6. Creditworthiness and exit options

Creditworthiness is one of the most important factors to consider. The creditworthiness of a bond issuer indicates the likelihood that the issuer shall make interest payments and repay the principal as soon as the bond matures.

Investors can assess the creditworthiness of a bond issuer by considering the issuer's financial strength, including its credit rating and its ability to generate cash flow.

When investing in bonds, it is crucial to learn your exit options. You may want to hold the bond until maturity, or you may need to sell it before then. If the bonds are bought before maturity, you will receive the interest due on bonds until the date of sale.

Conclusion

In conclusion, before investing in bonds, one should know about the different types of bonds available, the benefits and risks associated with each type, and the process of how to buy and sell them. With this knowledge in hand, an investor can make informed decisions about which bonds are right for them and their portfolio.

Disclaimer: ICICI Securities Ltd. (I-Sec). Registered office of I-Sec is at ICICI Securities Ltd. - ICICI Venture House, Appasaheb Marathe Marg, Prabhadevi, Mumbai - 400 025, India, Tel No : 022 - 6807 7100. The contents herein above shall not be considered as an invitation or persuasion to trade or invest. I-Sec and affiliates accept no liabilities for any loss or damage of any kind arising out of any actions taken in reliance thereon. The contents herein above are solely for informational purpose and may not be used or considered as an offer document or solicitation of offer to buy or sell or subscribe for securities or other financial instruments or any other product. Investments in securities market are subject to market risks, read all the related documents carefully before investing. Investors should consult their financial advisers whether the product is suitable for them before taking any decision. The contents herein mentioned are solely for informational and educational purpose.