Introduction to Bonds

Bonds

These are fixed-income instruments issued by the government or corporations to raise funds from the public or institutional investors.

Government Bonds (G-Secs)

• It is issued by the Government of India to fund its fiscal deficit and considered as extremely safe due to government backing.
• Types include long-term government bonds, Treasury Bills (short-term), and inflation-indexed bonds.
• Examples: 10-year G-Secs, 91-day and 364-day T-bills.

Treasury Bills (T-bills)

• These are essentially short-term government securities with a maturity period ranging from 91 days to 365 days.
• They are issued at a discount to their face value, and upon maturity, the full face value is paid to the investor.
• The difference between the issue price and the face value represents the interest earned by the investor.
• There is no capital gains tax on T-bills if held to maturity since there is no market price fluctuation. However, if sold before maturity, capital gains tax may apply on any gain made.
• The interest earned from T-bills is added to your total income and taxed according to the applicable tax slab

RBI Retail Direct scheme

State Bonds

• It is issued by individual state governments in India.
• It is used to fund state-level projects and initiatives.
• Backed by the respective state government, so they carry a slightly higher risk than central government bonds.
• Generally offer a slightly higher interest rate than central government bonds due to this risk.

Corporate Bonds

• It is issued by corporations to raise funds for business expansion, projects, or working capital.
• It offers higher interest rates than government bonds but come with a higher credit risk.
• Quality and risk are measured by credit ratings from agencies like CRISIL, ICRA, or CARE.
• Example: Reliance Industries, Tata Capital, and HDFC corporate bonds.

Inflation-Indexed Bonds (IIBs)

• It is issued by the Government of India.
• The interest payments and principal repayments are linked to inflation, protecting the investor from inflationary risk.
• Payments are adjusted based on changes in the Consumer Price Index (CPI).
• Ideal for investors seeking to preserve purchasing power over the long term.

RBI Bonds (Floating Rate Savings Bonds)

• It is issued by the Reserve Bank of India with a 7-year maturity period.
• The interest rate is floating, linked to the National Savings Certificate (NSC) rate, and adjusted every six months.
• It is designed for risk-averse investors seeking regular income with some interest rate adjustment to reflect the market.

Municipal Bonds

• It is issued by municipal bodies to fund local infrastructure projects like water supply and sanitation.
• It offers tax-free interest in some cases, making them attractive for investors looking to invest in urban development.
• Example: Bonds issued by Pune Municipal Corporation or Ahmedabad Municipal Corporation.

Coupon rate/Interest

• It is the interest rate that the bond issuer agrees to pay annually or semi-annually on the bond's face value (the amount borrowed).
• It is usually expressed as a percentage of the bond's face value (par value).
• Interest rates on bonds are influenced by the central bank's (such as the RBI in India) monetary policy
• Example: If you buy a bond with a ₹1,000 face value and a 6% coupon rate, you will receive ₹60 (6% of ₹1,000) in interest payments per year.

Ratings

These are evaluations given by credit rating agencies (like S&P, Moody’s, Fitch) that indicate the creditworthiness or risk level of a bond issuer.

Open Market Operations (OMO)

• It refers to the buying and selling of government securities (G-Secs, bonds, etc.) by the Reserve Bank of India (RBI) in the open market to regulate liquidity in the banking system.

How OMO Works?

1) When RBI BUYS government securities

• Injects liquidity into the economy.
• Banks get more money, leading to lower interest rates and easier credit.
• Encourages borrowing and spending, boosting economic activity.

2) When RBI SELLS government securities

• Drains excess liquidity from the system.
• Banks have less money to lend, causing interest rates to rise.
• Reduces inflation by slowing down spending and credit growth.

Why Does RBI Use OMO?

• To control inflation and stabilize prices.
• To manage money supply in the economy.
• To support economic growth by adjusting liquidity.

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