Bonds are fixed income securities which provide a fixed amount of interest in regular installments over a period of time or in a lump sum at maturity.
Categories of Bonds:
1.) Zero-coupon Bonds
These bonds do not have fixed coupons/interest. The interest is the difference between the issue price and redemption price. These bonds are generally issued at discount.
2.) Fixed rate coupon Bonds
These bonds pay a fixed amount of interest at regular intervals for a particular tenure. These are issued by the corporates, NBFC’s, RBI, Government Bonds, etc.
3.) Floating rate coupon Bonds
These bonds don’t pay fixed interest. The interest of these bonds is linked to some reference rate.
4.) Perpetual Bonds
These bonds do not have a fixed maturity date. These bonds have embedded option like call option or put option. A call option is an option in the hands of the issuer and the put option is in the hands of the investor.
The risk associated with investing in bonds:
1.) Default Risk
Default risk arises when the issues are not able to service its interest/maturity obligations on time.
2.) Interest Rate Risk
It refers to risk when interest rates in the prevailing market rise, your bond values will fall and vice versa
3.) Liquidity Risk
In comparison to equity, the secondary market for bonds is not very active. So, if an investor wishes to sell his/her bond before maturity, then there is a probability that you may get less than the market value. However, the Fixed Deposit of banks is fairly liquid in nature. Today, most banks charge a penalty for the premature exit.
4.) Inflation Risk
It is also known as purchasing power risk. It is a possibility that the value of income will decrease in the future as inflation shrinks the purchasing power of your income. Inflation decreases the value of money with a particular rate whether the money is invested or not.