Bonds : What Are Bonds?

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A bond is a loan to a company or government. It pays investors a fixed rate of return. In simple terms, a bond is a loan from an investor to a borrower such as a company or government. Borrower uses the money to fund its operations, and the investor receives interest on the investment. The market value of a bond can change over time.

Types Of Bonds

Government Bonds

A government bond is a debt instrument issued by the central and state Government of India. Issuance of such bonds occur when the issuing body faces a liquidity crisis and requires funds for the purpose of infrastructure development.

Municipal Bonds

Municipal bonds are debt securities issued by states, cities, countries and other governmental entities to fund day-to-day obligations and to finance capital projects such as building schools, highways, sewer systems. By purchasing municipal bond, you are lending money to the bond issuer in exchange for a promise of regular interest payments.

Corporate bonds

Corporate bonds are debt securities issued by private and public corporations. Companies issue corporate bonds to raise money for variety of purposes, such as building a new plant, purchasing equipment, or growing the business. When one buys a corporate bond, one lends money to the “issuer,” the company that issued the bond. In exchange, the company promises to return the money.

Zero Coupon Bonds

It is a bond that pays no interest and trades at a discount to its face value. It is also called a pure discount bond or deep discount bond.

Example of a Zero-Coupon Bonds

Example: Annual Compounding

Ankit is looking to purchase a Zero-Coupon bond with a face value of $1,000 and 5 Years to maturity. The interest rate on the bond is 5% compounded annually. What price will john pay for the bond today?

Price Of bond = $1,000 / (1+0.05)5 = $783.53

Bond Derivatives

Bonds can also be offered as components of a financial derivative. One such product that has gained popularity in the past few years is the principal protected note (PPN). PPNs typically allow investors to participate in market gains while also acting like a bond by guaranteeing the amount invested. 

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