All about bonds

Last week a set of gold schemes was unveiled by the prime minister Narendar Modi with a unique purpose to encourage as well as discourage the attitude of investors of gold.
All about bonds
Representational Pic

Last week a set of gold schemes was unveiled by the prime minister Narendar Modi with a unique purpose to encourage as well as discourage the attitude of investors of gold. Gold Deposit Scheme has been launched to encourage households and institutions to bring out their gold holdings for productive use, while as Sovereign Gold Deposit Bond has been introduced to discourage further physical buying of gold in paper form in order to address investment demand for gold in the country. These Gold Bonds would reduce physical demand for gold and in turn reduce gold imports.

The bond will be backed a sovereign guarantee, but not by gold. The investors will get interest on the gold bond at 2.75 per cent which will be subject to tax and on maturity will get the prevailing value of gold at that time. For investors who hold physical stock of gold in gold bars and coins have this opportunity to hold gold in the shape of paper bond. This would bring down the cost of their gold holdings in terms of handling and storage costs.

As per the scheme, the counterparty in gold bond is the government of India. If the price of gold increases, the government takes the risk of higher prices, if they fall, the investor would be given an option to roll over their holdings for an additional period.

Since the features of these bonds stand circulated, a huge chunk of our local investors are not acquainted with the investment opportunity through bonds – a fixed income investment instrument.

Let me take you through investment in bonds. It is considered as good as ploughing money with a lesser risk of losing it. Bonds are considered a good investment avenue from a short-term perspective and safer than equities. The most important advantage of investing in bonds is that it helps you to have a diversified investment portfolio and grow your money.

Importantly, as experts say, for the purposes of diversifying your investment portfolio, bonds typically have little correlation with the stock market, meaning that if equities plummet, bond values aren't necessarily adversely affected.

We have mainly two types of bonds – Corporate bonds and Government bonds. First of all let me reproduce some basics about the bonds. What are bonds? Experts call a bond simply as an 'IOU' (I owe you) in which an investor agrees to loan money to a company or government in exchange for a predetermined interest rate for a pre-determined length of time.

A company needs funds to expand its existing business or to foray into new markets. A government may need money to raise infrastructure or run some projects for the benefits of its people. The quantum of money needed is so huge that typically an average bank cannot provide such huge finance. Under these circumstances, the company or the government raise loans from the public by issuing debt instruments and bond is one such debt instrument.

So, the basic thing about a bond is that it is a loan where borrower (company or the government) is the issuer and the lender is the investor. In return, the issuer promises to pay a set amount of interest every year, plus the capital at a set date (maturity date) in the future.

The interest payments are made at a predetermined rate and schedule. By investing in bonds you know the exact amount of cash you will get back while holding it till maturity. And that's why bonds are known as fixed-income instruments or securities.

Meanwhile, the bonds issued by companies or corporate to raise capital are called corporate bonds. Here we have convertible bonds & non convertible bonds. Convertible bonds can be converted into a pre-defined number of stocks as and when required by the investor. Non-Convertible bonds are just plain bonds. The bonds issued by Government to fund their projects are called government bonds. Also referred as G-Sec, these bonds constitute larger portion of the bond market than the corporate bonds. At the moment, experts view the bond market stronger and profitable.

Even as bonds are among the safest investments avenues, they are not also risk free. 

To be precise, there is generally less risk in owning bonds than in owning stocks, but this comes at the cost of a lower return. 

Meanwhile, how relevant is gold deposit scheme and gold bond will  be discussed next week. 

(The views are of the author & not the institution he works for.)
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