Investment

What Are Bonds?

In simple words, a bond is a loan that you give to a corporate entity or the government,and earn regular interest in return.

In simple words, a bond is a loan that you give to a corporate entity or the government,and earn regular interest in return.

If a company intends to expand or diversify its business, one of the methods it uses to raise money is issuance of bonds. By investing in these bonds, you loan your money to the issuing company, which promises to return your investment after a certain period; until then, it pays interest.

Apart from corporate entities, governments also issue bonds to reduce fiscal deficit and fund other financial activities.

Understanding bonds

When a bond is issued, the price you pay is called the 'face value' of that bond. The rate of interest is known as the 'coupon rate', and the date at which it matures is the 'maturity date'.

This can be further explained with the help of an example. Say for instance, you buy a bond with Rs 20,000 face value at a 5 percent coupon rate and a 10-year maturity. You will receive Rs 20,000 (your initial investment) at the end of 10 years, plus Rs 1000 every year for 10 years as regular interest payment.

While most bonds offer interest on your investment, there are exceptions like zero-coupon bonds, which, as the name suggests, do not pay interest. Instead, they offer discount on the face value while buying.

How are bonds different from stocks?

When you purchase a stock, you become one of the owners of the company. As a result, you receive profits of the company in the form of dividends. In case of a bond, you are not the owner, but rather a lender to the issuing company. Hence, instead of dividends, you receive regular interest for the amount you lend.

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