The financial markets are a result of two sets of people. One set needs money while the other set is ready to provide it. Corporates, as well as governments, need money to fund various expansion or development plans. Companies require external funding to set up new factories, launch new products or enter new geographies, while governments need external money to fund developmental projects or pare debt. Both entities have various avenues to access funds. Companies can offer equity to new investors. Governments can sell stake in state-owned companies to raise funds. An alternate way of raising funds without selling any stake is to issue a debt instrument, also known as bonds.
What are bonds?
Bonds are fixed-income instruments that signify a loan forwarded by an investor to a borrower. Bonds are issued by entities to raise money from investors for a certain amount of time. The issuer promises to pay a specific interest for the life of the bond and the principal amount or the face value at maturity. Bonds are generally issued by governments, corporations, municipalities and other sovereign bodies. Bonds can be traded, just like securities.
What is the bond market?
The market for trading debt securities like government bonds, corporate bonds and tax-free bonds is known as a bond market. A bond market is generally less volatile than an equity market and is more suitable for investors with lower risk tolerance. Investing in bond markets is an efficient way to diversify your portfolio. The Indian bond market has grown by leaps and bounds after liberalisation. With many foreign investors holding a certain proportion of fixed-income instruments in their portfolios, the Indian bond market has witnessed strong inflows of foreign capital in the past few decades. The primary role of a bond market is to help the government and large private entities access long term capital.
Types of bond markets
There are different types of bonds markets depending on the type of bond and the type of buyers. On the basis of buyers, there are two types of bond markets—primary market and secondary market. The primary market is the one where the bond issuer directly sells the bonds to investors. Primary markets witness the issuance of new debt securities.
On the other side of the spectrum is the secondary market. The bond market definition includes flexibility. The bonds bought in the primary market can be traded in the secondary market. Brokers help in buying and selling of the bonds in the secondary market.
There are various types of bonds like government bonds and municipal bonds. There are different types of bond markets on the basis of these products. While there are different types of bonds, in India, government bonds and corporate bonds dominate the bond market. Between the two, government bonds have a larger proportion in the Indian bond market.
– Corporate bonds: These bonds are issued by companies to fund a variety of activities like opening new facilities, entering new markets or financing current operations. Corporate bond investors get paid at a fixed rate of interest at regular intervals. There are two types of corporate bonds – convertible and non-convertible.
– Convertible bonds can be converted into a specific percentage of equity when required by the investor. Non-convertible bonds are plain and simple corporate bonds and cannot be converted into equity.
– Government bonds: Government bonds form a bulk of the Indian bond market. The bonds issued by the Indian government to finance activities like infrastructure development or reduce interest payout is known as government bonds or G-secs. Government bonds generally offer stable returns and are considered extremely safe as they are guaranteed by the Indian government. The interest rate on G-sec varies between 7% and 10% and the maturity duration can be anywhere between 3 months to 30 years.
– Municipal bonds: The municipal bond market is in the nascent stage in India. Municipal bonds are issued by urban local bodies to fund projects like building roads, bridges and schools. The interest is paid to the investors through the returns generated by the developed infrastructure. A number of local bodies in India have issued municipal bonds and more are likely to issue in the future.
The Indian bond market has matured significantly in the last few years. The bond market in India has high liquidity and has adequate stability, providing a relatively safe investment avenue to risk-averse investors.