What are bonds?

Ans:- In simple word Bonds are loans, when you buy a bond, you are providing loan to a bond issuer (which may be companies, Municipalities, Governments etc.).

When a bond issuer issues bonds to raise money, they are contractually obliged to pay you :- a specified rate of interest during the life of the bond and also the principal amount.

These payments are generally fixed in advance, hence it is also known as FIXED INCOME Instrument.

Example:- Suppose a company wanted to borrow $100 million from investors to acquire other company. they are offering a bond with a 5% coupon rate (interest rate) that pays interest semi-annually and mature in 10 years. it issues each bond at a face value of $1000. company approaches investors who invest in the bonds.

In this case company needs to sell 1 Lac bonds to raise its desire $100 million.

Now, each $1000 bond is going to receive $50 per year in interest, since the interest payment is semi-annual, it is going to arrive $25 every six months. if all goes well, at the end of 10 years, the original $1000 will be refunded on the maturity date and the bond will ceases to exist.

Who is the issuer of a Bond?

Ans:-

♦ By Corporates

Companies routinely borrow funds as part of their overall capital structure, both to fund short-term spending needs (e.g. Working Capital) as well as Long-term Capital investments. Ways are :-

Bank Loan:- Bank loans are the primary source of debt financing for small, medium-size as well as large companies in countries where bond markets are under-developed. Access to banks loans depends not only the characteristics and financial health of the company, but also on market conditions and bank capital availability.

Commercial Paper:- Commercial paper is a short-term source of procurement of funds. It is a source of funding for working capital and seasonal demands for cash. Sometime when the market conditions for issuing long-term bonds are volatile, which would translate into a higher cost of borrowing, Rather than issuing long-term bonds immediately, the company may opt to raise funds with commercial paper and wait for a more favorable environment in which to issue long-term bonds.

Corporate Bond:- it is also known as corporate note. Companies are regularly issue corporate bonds. There is no universal accepted maturities, it may be a short-term corporate bond maturities of 5 years or less or; a intermediate-term maturities longer than 5 years and up to 10 years; and a long-term maturities longer than 10 years. ➭ Source of repayment is primary cashflow generated from operations. ➭ Corporate bonds have a range of coupon(interest) payment structures, whether the periodic coupon is fixed or not, coupon payments can be made quarterly, semi-annually, or annually depending on the type of bond (Zero-coupon bonds pay no coupons). ➭ Principal Repayment:- Corporate bond issues have either a series or a term maturity structure. with a Series maturity structure, the bond's Principal amount are paid off each year, dates are spread out during the bond's life. With a Term maturity structure, the bond's principal is paid off in a Lump-sum at maturity.

♦ By Government

Agency Bonds:- Bonds issued by agencies of government (like:- Municipalities, National Highway authority of India, etc.), These organizations often have both public and private sector characteristics and also referred as quasi-government bonds. ➭Source of repayment :- Taxes, Project Revenue, Special Fees.

Sovereign Government Bonds :- National government (Central Government) issue sovereign govt. bonds to fund its spending, when Tax revenues are insufficient to cover government spending. ➭Source of repayment:-When a national government runs a budget surplus(Tax revenue is more than Expenditure) is the prime source for making interest payments and principal payments.

Non-Sovereign Government Bonds :- Bond issued by State government, Provinces, Cities are called Non-sovereign govt. bonds. these bonds are typically issued to finance public projects, such as Schools, Hospitals, Bridges, Airports etc. ➭Source of repayments:- The source for paying interest and repayment of principals to investors, include the taxes, the cashflows of the project the bond is issue is financing, Special taxes and Fees established for the purpose of making interest and principal payments.

Supra National Bond :- Bonds issued by supranational agencies, such as the World Bank, the International Monetary Fund (IMF), the European International Bank (EIB), the Asian Development Bank (ADB), and the African Development Bank (AFDB). ➭Source of repayments:- The prime source of payment of interest and repayment of principals comes from, Amount received as loan repayment from various nations, Capital Contribution by member nations.

What are the different types of bonds?

Ans:- Global Fixed income (Bond) market can be classified on several Basis:-

💢On the basis of issuer:-

💢On the Basis Of Credit Quality:-

➞ Investment Grade Bonds:- Rating of Baa3 or above by Moody's Investors Service or, BBB or above by Standards & Poor's (S&P) and Fitch Rating are considered as Investment grade Bond.

➞ Junk Bonds:- Rating below Baa3 or BBB levels are referred as non-investment grade, Speculative or Junk bonds.

Credit ratings are not static, they will change if a credit rating agency perceives that the probability of default for an issuer of bond has changed.

💢On the Basis of Coupon:-

➞ Zero Coupon Bond (ZCB) :- Zero-coupon bonds pay no coupons.

➞ Fixed Coupon Bond :- Bonds pay a fixed rate of interest till maturity and in last Bullet redemption (Repayment of principle in one shot).

➞ Floating Rate bond or note (FRN):- In an FRN, coupon rate is not fixed. Here coupon rate is market rate, which is Reference rate (like:- LIBOR, etc.) + Spread (Spread is fixed based on credit quality of the issuer at the time of issuance).

💢On the basis of Maturity:-

➞ If original maturity is less than one year, it is known as Money market instrument.

Treasury Bill (T-Bill):- Issued by government.
Commercial Paper (CP) :- Issued by corporates.
Certificate of Deposits (CD):- Issued by Financial institutions like banks.

➞ If original maturity is more than one year, it is known as Capital market instrument.

💢On the basis of Geography:-

➞ Domestic bond:- Bonds issued in a specific country, denominated in the currency of that country and sold in that by an issuer domicile in that country are classified as domestic bonds.

Example:- USA's company issues Dollar denominated bond in USA.

➞ Foreign bond:- Bonds issued in a specific country, denominated in the currency of that country and sold in that by an issuer domicile in another country are classified as Foreign bonds.

Example:- Dollar denominated bond issued in USA Non-US companies.

➞ Euro bond:- Eurobond is issued internationally, outside the jurisdiction of a country in whose currency the bond is denominated. Example:- Dollar denominated bond issued outside USA by anyone.

➞ Emerging market bond:- Countries where the capital markets are in earlier stages of development is called emerging market. emerging bond markets are much smaller than developed bond markets, but emerging market bonds usually offer higher return (yields) than developed market bonds because of the perceived risk.

💢On the basis of Tax Status:-

➞ Certain bonds are tax exempts like:- Municipal bonds.

➞ Yield on tax exempt bonds would be lower than Pre-tax yield of taxable bond.

What is Bond Indenture & Covenants?

Ans:- Bonds are issued with a certificate. it is a contractual agreement between issuer and bondholders and it is subject to legal consideration.

When an entity issues a bond, it appoints a Financial Institution as a Trustee.

➞ Trustee is appointed by the issuer of bond, but it acts in a fiduciary responsibility with the bond holders. Ofcourse most of the responsibility are administrative in nature. Like:-

Trustee's role is to Monitor that the issuer complies with the obligations specified in the indenture and to take action on behalf of the bond holders when necessary.

Raising invoice on the Company and paying interests and principal to bond holders.

Holding beneficial title to, safeguarding, and appraising collateral (if any).

Holding funds until they are paid.

The trustee is responsible for calling meetings of bondholders to discuss the actions to take.

In actuality the role of the trustee becomes very important in case of company defaults.

Bond Indenture or Trust Deed

Bond Indenture or deed is a written document between the issuer of a bond and bond holders. it is the legal contract that describe:-

➧ the form of bond,

➧ the obligation of the issuer, and

➧ the rights of the bond holders.

Bond indenture also describe the features of the bond, such as the principal value for each bond, the interest rate or coupon rate to be paid, the dates when the interest payments will be maid, the maturity date when the bonds will be repaid, and whether the bond issue comes with any contingency provisions.

The bond deed also includes information regarding the funding sources for the interest payments and principal repayments, and it specifies any collaterals, credit enhancements, or covenants.

✦ Investors should carefully review the following areas:-

➭ The legal identity of the bond issuer and its legal form,

➭ The source of repayment proceeds,

➭ The asset or collateral backing (if any),

➭ The credit enhancement (if any).

➭ The covenants (if any).

Covenants

Bond covenants are set of rules that borrowers and lenders agree on, at the time of a bond issue. Covenants are generally of two types:-

How to invest in bonds?

Ans:- Investment in bonds can be done via Primary Market or Secondary Market.

Primary Market:-

it is a place were new bonds are issued and fresh funds are raised. New securities are issued in this market for the first time for investors to purchase. Investors can purchase such securities in the following ways:- By

⟶ Public Offering:-

A public offering of bond is a sale, by an organization to the general public in order to raise funds.

In case of public offering an investment bank or syndicate of investment bank has to be appointed as an underwriter (broker/dealer) to assist the bond issue.

The price at which issue of bonds open, depend upon the Demand-Supply conditions and can be inferred from the gray market also known as when issued market.

⟶ Private Placement :-

A private placement is a sale of Securities (stock, shares or bonds) to pre-selected investors (generally high net worth individuals HNIs) and institutional investors, which are typically Financial institutions (like:- Banks, Mutual Funds, Insurance Companies, etc.) rather than sale on the open market(public offering).

It is an alternative way for an entity seeking to raise Capital for expansion.

Advantages of using Private placements:-

⇨ It allow the issuer to choose its investors.

⇨ it allow the issuer to remain a private company, rather than having to go public to raise finance.

⇨ it Provide Flexibility in the amount and type of funding.

Secondary Market:-

Secondary market or After market is a place where existing bonds are traded. Fresh funds are not raised in the secondary market.

Although there are certain Exchanges where certain bonds are traded, but most of the bonds are traded Over-the-counter (OTC). it is dealers market, thus dealer provide "Bid / Ask" Quote (rate).

Price of a bond has to be estimated using the price of similar bonds (Matrix Pricing).

For those looking for an investment option with steady income and relatively lower risk, bonds can be a good option.

You must consult a Financial Adviser before investing your hard earned money.

Thank You.. Stay Happy and Safe..

Detailed Explanation on Bonds- Who is the issuer & How to invest in bonds?