What are Bonds?
A bond is a debt
security, in which the authorised issuer company, financial institution, or
Government, offers regular or fixed payment of interest in return for the money
borrowed by the said issuer. It is for a certain period of time.
How do bonds work?
o
When you purchase a bond, the authorised issuer
borrows money from you for a fixed period of time.
o
This money earns you a predetermined interest rate
at regular intervals.
o
The principal amount is repaid at the end of the
maturity period.
Are bonds and stocks the
same?
It was stated earlier that bonds are as good as
debts. So, if you are a bondholder, it means that you are a lender of funds to the issuer
entity. On the other hand, if you own a stock, it indicates that you have
a share in the ownership of
such issuer organization.
Bonds are
having predefined maturity periods while stocks don’t. Anyways, if you invest
in stocks, you can sell them off any day. But, if you are a holder of bonds,
you have to wait for its maturity period to end to get back your investments
How to
buy government bonds in India
When a
person wants to buy a risk free investment,
which is the best investment vehicle? Government bonds will be the best choice.
Why?
There are
two reasons for it:
(a) Bonds are regulated and managed by Reserve Bank of
India (RBI).
(b) Government bonds are issued by the central
government in India.
Government Bonds
What are
bonds and T-bills? These are Securities (G-secs) issued by the government of
India to borrow money from investors. Who are investors?
§ Big
Investors: Banks, insurance companies, mutual funds, trusts, corporates etc.
These are called big because their size of investment (in G-Secs) are large
compared to small investors.
§ Small
Investors: HNI’s, NRIs, HUF members, individuals etc. In this group of
people, ‘individual investors’ are the ones where we common men are placed.
Government
borrows money from these investors by offering them G-secs through “auctions“. How the auction is done? Through “competitive bidding” process.
Government Bonds – Process of Purchase
Before Nov’2017, Government Securities (G-Secs) like bonds and T-bills were virtually non-accessible for common men (small investors). But then RBI started the “Non-competitive Bidding Facility“. This made G-secs more accessible for common men.
Lets
understand more about competitive and non-competitive bidding process:
§ Competitive
bidding: Example: Government issues a bond of Face Value of Rs.1,000, offering
an interest @8.0% p.a. In the competitive bidding process (auction), “investors” will quote a price higher than
the face value (Rs.1,000). Suppose based on all bids, RBI accepts a cut-off
price as Rs.1,060. In this case everyone who has quoted Rs.1,060 or more will
get their quoted lot of the bond. [Note: In this case, their yield will be
lower than 8.0%. How much lower? 7.54% (=8.0% /
1,060 * 1000)].
§ Non-competitive
bidding: RBI’s “non-competitive bidding facility”
for retail investors like me and you. Small investors just need to access the
mobile and web app of NSE.
How Retail Investor can buy government bonds
Small investors like me and you can buy government bonds in India using a mobile app or a web based app of National Stock Exchange (NSE). This app is called “NSE goBID“. Either of these two apps can be used to buy the following:
Small investors like me and you can buy government bonds in India using a mobile app or a web based app of National Stock Exchange (NSE). This app is called “NSE goBID“. Either of these two apps can be used to buy the following:
§ Long-dated
government bonds: holding time: 5 to 40 year.
§ Treasury
bills (T-bills): holding time less than 1 year.
Before
one can go ahead and buy the government bonds using NSE goBID,
the “process of registration” must be completed. But do not worry,
everything is online.
When bonds are useful for Retail Investor
Generally
speaking, when common men invest money, they do it for wealth creation. Hence,
they often invest with a long term perspective (5+ years). Equity based
investment options can give much higher returns than bonds.
In India,
a government bond will yield returns between 7-8% per annum even in long term.
But a good equity based plan can easily give 14% p.a. in a time horizon of 5+
years.
Hence,
there are less takers of Government bonds when it comes to retail investors.
But over last decade, even common men have started building their investment
portfolio. They are buying range of securities to keep their portfolio well diversified.
On one
side when there is equity, there can be no better investment diversification
alternative than government backed
securities. This is where common men must consider investing in T-secs
and government bonds.
What type of Bonds are best for Retail Investor?
If common
man decides to invest in bonds for income generation, best alternative will
be tax free government bonds. Why? Because the interest
income generated from such government bonds are free of
income tax.
This
becomes specially lucrative for those people who are in the maximum tax bracket
(30%+).
Suppose
there are two bonds available for investing. One is tax free bond, and the
other is non-tax free bond. Generally the yield of tax free bonds is less than
non-tax free bonds. Which one must select? The decision making should be done
based on the following formula:
Net Yield =
Bond yield * (1 – your tax rate)
Suppose
there is a person’s whose tax rate is 30%. For tax-free bonds, Net yield =
bond yield. For non-tax free bonds, net yield = bond yield * (1 – 0.3) =
bond yield * 0.7. Example:
§ Tax Free
Bond
§ Yield =
8%
§ Net Yield
= 8%
§ Non Tax
Free Bond
§ Yield =
10%
§ Net Yield
= 7%
Where to find a list of tax free bonds in India?
On
the NSEgoBID app’s dashboard, list of government bonds
will be available. Generally all government bonds are of tax free in nature.
Apart
from government bonds, there are also corporate
bonds. We also know corporate bonds as Company Deposits.
One of
the reliable sources to get a list of all tax free bonds is karvy. By default this
list is sorted for top performing
bonds. Make sure to click the “[+] show all” options to get the list of
all bonds.
Following
information’s of bonds are easily accessible from this list (click on each bond
to see the details):
Example:
Indiabulls Housing Finance Ltd:
§ Face
Value: Rs.1,000
§ Coupon
rate (interest): 8.55% p.a.
§ Credit
Rating: CARE AAA
§ Last
Price: Rs.1.040
§ Allotment
Date: 26-Sep-2016
§ Redemption
Date: 26-Sep-2019.
§ Tenor: 36
months (3 Years).
§ Trading
volume: 20
How to sell government bonds?
Before we
discuss how to sell bonds, let’s understand a close analogy between stocks and
bonds.
Most of
the government bonds are listed in stock exchange (secondary market) for
trading. In normal circumstances, a person should buy a government bond, and
hold it till its full tenure (example 5,10,15,
20, 30 years as applicable).
But those
bonds which are listed in secondary market, can be sold to the interested
buyers. What we can understand from this?
1. A person
can buy bonds both in primary market or in secondary market.
2. A person
need not hold the bonds for its full tenure. It can be sold in between, to
another buyer in secondary market.
So this
becomes as good as stocks right? Not really. Why? Because of the low trading volumes of bonds in the secondary
market. So what? This means, even if one wants to buy/sell bonds in
secondary market, there will be less traders available for it.
Low trading
volumes are due to low demand for
bonds. Moreover, real bond investors generally buy bonds (like tax free, long
dated government bonds) for very long holding times. They do not like to sell
mid-way.
