Bonds

Today, it is better to invest in Bonds rather than FDs. Let me tell you why:

1. Bonds are Stable Fixed Income Securities
   Bonds are predictable. You know how much interest you can expect to receive, how often you'll receive it, and when your principal (the bond's face value) will be repaid (maturity date).Bonds are steadier than stocks (which can fluctuate wildly short-term). Nervous investors usually sleep better by buying bonds instead of equity investments.
   
2. Bond Interest rates are higher
   FD rates are lower than bond interest rates. Banks have to maintain CRR (Cash Reserve Ratio) as per regulations laid down by the central bank. The banks must reserve a portion of capital received via FDs; entire capital cannot be lent out. This reserved capital can be utilized to supply closures (or pre-closures) in FD. Such constraints are not there on banks on the capital that is raised via bonds. Hence bond rates are higher than FD rates.Bonds are tradable; hence you can sell when interest rates increase, resulting in capital gain. FDs are not tradable, and they come with fixed lock-in. The investor has to pay the penalty on premature closure of FD. Both FD and bonds fall into the category of low-risk securities.
   
3. Bonds may provide Tax Advantages
   While the income on FDs & interest on bonds are both taxable at your slab rates, with bonds the difference is that if one sells the bond after a holding period of 1/3 years(Depending upon whether the bond is listed or unlisted) but before maturity, at a premium then he/she may enjoy a tax advantage since the gains will be taxed as long term capital gains @ 10%/30% (Depending upon whether the bond is listed or unlisted).
   

Bonds are considered a safe haven, but bonds do come with a couple of risks. So, now let’s talk about them.

The term “Risk in Bond Investment’’ sounds like an oxymoron. Because once we hear the word “Bonds”, what comes to our mind is: bonds are debt investments, they give fixed returns and are safe. Nevertheless, bonds do come with a couple of risks. Let’s get aware of them and learn a few simple strategies on how to mitigate them. If you are not sure of terminologies used in the Bond market you may refer our blog here - ‘The ABC of Bonds’.

In the bond market, risk of not getting interest payments/principal amount back on your investment is termed as “Credit Risk” 

Credit Risk:

One of the key risks of investing in Bonds is the risk of facing non-payment of interest or principal or both by the Bond issuer. This loss to the bond buyer is called the credit risk. It can happen if the bond issuer runs into financial trouble and is incapable of paying. Hence, while picking up bonds, it is especially important to invest in entities that have sound financial performance. 

Resolution for credit risk: Go for “AAA” rated bonds, these bonds are less risky than other lower-rated bonds. 

Interest Rate Risk:

First and foremost, please note: Bond prices and interest rates are inversely proportional.

Interest Rate Risk is the risk of getting a lower sell price than the price at which the bondholder bought the bonds in the first place. Different factors influence Interest Rates i.e. Monetary Policy, Inflation, and the strength of the economy. If interest rates increase the price of the bond decreases. At this time if the investor wants to sell the bonds, he/she has to sell at a discount price. 

However, the flip side is that, if the interest rates in the economy decrease, the selling price of bonds will increase. At such a time, an investor can make capital gains by selling his bonds at a premium to his buy price.

Example: 

Let’s assume you are holding bonds issued by XYZ company at a purchase price of 100. At this time, the interest rates in the market are 7%.

Case 1: Now if interest rates increase to 8 %, bond price will fall in the market, to say 99. Then if you sell the bonds, you will lose ₹ 1 per bond.

Case 2: If the interest rate falls to 6%, then the bond price can increase to, say ₹ 101. Then if you sell the bonds, you will earn capital gains of ₹ 1 per bond. 

Liquidity Risk:

Liquidity is the ease of selling off a bond in the market and getting cash in return. This risk of monetary loss due to a smaller number of buyers/ low demand for a given security is termed as Liquidity Risk. 

Note: Liquidity risk arises only when you want to sell off the bond before it matures. Factors that influence liquidity risk are:

• Demand 
• Market Price 
• Associated Risk 
• Lack of information 

One major factor that triggers liquidity risk is ‘Lack of information’ on the demand side. When a seller is unaware of the number of buyers looking to buy bonds, we can say he is unaware of demand and may develop a misconception of low demand.  He then agrees to sell the bonds at a discount price.

Way out: Innovation in technology can mitigate this liquidity risk. For Listed Bonds one can check the last traded price by searching the ISIN of the bond over BSE/NSE’s Website and for unlisted bonds, websites like ours can connect buyers and sellers.

So, I want to invest in a bond instrument.

I don’t like the low interest rates of FDs.

But I don’t want to take unnecessary risk.

What should I do?

Buy a Bond and use the Hold to Maturity Strategy (HTM). If you plan to hold bonds till maturity, Liquidity risk and Interest rate risk will not come into picture. Liquidity risk can be handled efficiently with the help of the latest connective technological innovations and players like we ourselves. So here, if you hold the bonds till maturity the only risk you take is Credit Risk i.e. If the issuer is financially sound and makes payments on time, you will get your money back on maturity.

Upgrade to fixed income investments with Richfield Fintech. Held exclusively by Banks, Corporates, HNIs and other large financial institutions up until now, we’ve opened up the fixed income investment market to individual investors like you.

TYPE OF SECURITY	HOLDING PERIOD TO QUALIFY AS A LONG-TERM ASSET	TAXABILITY OF SHORT-TERM CAPITAL GAINS	TAXABILITY OF LONG-TERM CAPITAL GAINS
Listed debentures and bonds *	More than 12 months	Gains shall be taxed as per normal slab rates	Gains shall be taxed @ 10% without indexation
Unlisted debentures and bonds *	More than 36 months	Gains shall be taxed as per normal slab rates	Gains shall be taxed @ 20% with indexation