Investor Corner/The asset classes/Debt Concepts
2.2.1 What Is a Bond / Debt Instrument?
A bond is a loan. You lend money to a government or company, and in return you receive periodic interest plus your principal back at maturity, provided the borrower does not default along the way.
Lending, not owning
Buying a bond makes you a creditor, not an owner. This is the fundamental difference from equity. A shareholder's return depends on how well the business performs; a bondholder is promised a fixed schedule of payments regardless of whether the business does brilliantly or merely adequately, as long as it stays solvent enough to pay.
When you buy a bond, you are lending money to the issuer. In India, the issuer could be the central government (Government Securities or G-Secs), a state government, a public sector undertaking, a bank, or a private corporation. Each type of issuer carries a different level of credit risk, and that risk is reflected in the interest rate they must offer to attract lenders. The central government borrows at the lowest rate because it is considered virtually default-free; corporate issuers must pay more because the market demands compensation for the possibility, however small, that they might not repay.
The three things every bond promises
Every bond specifies a face value, the amount repaid at maturity; a coupon, the stated interest rate paid periodically; and a maturity date, when the loan is due to be repaid in full. Between issue and maturity, the bond's market price can move up or down, but the coupon and face value written into the bond itself generally do not change.
The three core components of a bond are its face value (the principal amount to be repaid at maturity), the coupon (the periodic interest payment, expressed as a percentage of face value), and the maturity date (when the principal is returned). A ₹1,000 face value bond with a 7% annual coupon maturing in 10 years promises ₹70 per year in interest and ₹1,000 back at the end. If the investor buys this bond at face value, the yield to maturity is 7%. If the bond is bought at a price below face value (at a discount), the effective yield is higher than 7% because the investor also gains from the price converging to face value at maturity.
Bonds trade in the secondary market, and their prices fluctuate with interest rates, credit conditions and supply-demand dynamics. This means a bondholder can sell before maturity, but the price may be above or below what was originally paid. The secondary market for government bonds in India is deep and liquid; for corporate bonds, liquidity is thinner and the bid-ask spread can be wider, especially for lower-rated issuers.
Why bonds sit in most portfolios
Bonds typically offer more predictable income and lower volatility than equity, which is why they form the stabilising part of most portfolios. That stability is not free of risk, however. The two main risks, changes in interest rates and the possibility of default, are large enough topics that they each deserve separate treatment.
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For most Indian retail investors, bond exposure comes through debt mutual funds rather than direct bond purchases. Debt funds pool money and invest in a portfolio of bonds, providing diversification across issuers and maturities that an individual investor with a modest sum could not achieve on their own. The fund's NAV fluctuates daily based on the marked-to-market value of its bond holdings, which is why even "safe" debt funds can show small negative returns over short periods when interest rates rise.