Types of Bonds: A Comprehensive Guide

Bonds are essential financial instruments. They represent a loan made by an investor to a borrower. Governments or corporations usually issue them. They use these funds for various needs. In return, bond issuers promise regular interest payments. They also repay the principal amount at maturity. Bonds offer predictability. They provide steady income. This makes them popular for many investors.

Here are the main types of bonds, focusing on the Indian context:

1. Government Securities (G-Secs)

G-Secs are debt instruments. The Central Government of India issues them. They finance its expenditure. The Reserve Bank of India (RBI) manages their issuance. G-Secs are highly secure investments. They carry virtually no credit risk. This is because the government guarantees repayment. They are often called “risk-free” assets.

• Features:
  • Issued by: Central Government of India.
  • Safety: Very high safety. Considered risk-free.
  • Purpose: Fund government projects, manage deficits.
  • Maturity: Long-term, usually 5 to 40 years.
  • Interest: Pay fixed or floating interest (coupon). Interest is paid semi-annually.
  • Taxation: Interest is taxable as per investor’s slab. Capital gains are also taxable.

• Examples of G-Secs:
  • Dated Government Securities (Dated G-Secs):
    • These are long-term bonds. They have a fixed maturity date. They typically range from 5 to 40 years.
    • They usually pay a fixed interest rate. This interest is called a coupon payment. Investors receive it semi-annually.
    • Example: You might see “7.26% GOI 2032.” This bond pays 7.26% interest. The Government of India issued it. It matures in 2032.

• Treasury Bills (T-Bills):
  • These are short-term G-Secs. Their maturity period is less than one year.
  • T-Bills do not pay explicit interest. They are “zero-coupon” instruments. The government issues them at a discount. Investors redeem them at their face value. The difference is the return.
  • Example: You could buy a 91-day T-Bill. The government issues it at Rs 98. It has a face value of Rs 100. You get Rs 100 after 91 days. Other common maturities are 182 days and 364 days.

• Cash Management Bills (CMBs):
  • These are very short-term T-Bills. They have maturities less than 91 days. The government uses them for urgent cash needs. RBI issues them on an as-needed basis.
  • Like T-Bills, they are zero-coupon. They are issued at a discount.
  • Example: The RBI might announce a 42-day CMB. It helps manage temporary cash flow mismatches.

• Floating Rate Bonds (FRBs):
  • These are dated G-Secs. Their interest rate is not fixed. It changes periodically. The rate links to a benchmark. This protects investors from interest rate fluctuations.
  • The coupon rate resets at regular intervals. This might be every six months. It links to a reference rate.
  • Example: You might find a “GOI Floating Rate Bond.” Its interest rate changes with the market.

• Sovereign Gold Bonds (SGBs):
  • These are unique G-Secs. They are denominated in grams of gold. The Central Government issues them. They serve as an alternative to physical gold.
  • They pay a fixed interest rate. Currently, it is 2.50% per annum. This interest is paid semi-annually.
  • Example: An SGB might track gold prices. It matures after eight years. Investors get the gold’s market value then. They also earn the fixed interest.

2. State Development Loans (SDLs)

SDLs are bonds. State Governments in India issue them. They raise funds for state-specific needs. These often include infrastructure projects. RBI manages their issuance. SDLs carry slightly more risk than G-Secs. This is because state governments have lower creditworthiness. Yet, they remain very safe.

• Features:
  • Issued by: Individual State Governments in India.
  • Safety: High safety, backed by state governments. Slightly higher risk than G-Secs.
  • Purpose: Fund state-level development projects.
  • Maturity: Medium to long-term, usually 5 to 20 years.
  • Interest: Pay fixed interest (coupon). Interest is paid semi-annually.
  • Taxation: Interest is taxable as per investor’s slab.

Examples of Issuers:

• Maharashtra State Development Loan (e.g., 7.50% Maharashtra SDL 2034)
• Uttar Pradesh State Development Loan (e.g., 7.81% Uttar Pradesh SDL 2033)
• Karnataka State Development Loan (e.g., 7.65% Karnataka SDL 2035)

3. Corporate Bonds

Companies issue corporate bonds. They raise capital for business needs. These can be private sector or public sector companies. Corporate bonds carry credit risk. This depends on the company’s financial health. Higher-rated companies issue safer bonds. Lower-rated companies offer higher interest.

• Features:
  • Issued by: Public and private sector companies.
  • Safety: Varies significantly. Depends on company’s credit rating.
  • Purpose: Fund business expansion, operations, projects.
  • Maturity: Can vary from short to very long-term.
  • Interest: Pay fixed or floating interest. Typically, higher than government bonds.
  • Taxation: Interest is fully taxable. Capital gains depend on holding period.

Examples of Issuers (typically AAA-rated for higher safety):

• HDFC Bank Limited Bonds
• Reliance Industries Limited Bonds
• Tata Motors Finance Solutions Bonds
• ICICI Home Finance Company Limited Bonds

4. PSU Bonds (Public Sector Undertaking Bonds)

PSU bonds are a type of corporate bond. Public Sector Undertakings issue them. These are companies where the government holds majority stake. Indian Oil, NTPC, PFC are examples. PSU bonds generally carry lower risk. Government backing provides added safety. They often offer higher interest than G-Secs.

• Features:
  • Issued by: Government-owned companies (PSUs).
  • Safety: High safety due to government backing. Safer than private corporate bonds.
  • Purpose: Fund operations and projects of PSUs.
  • Maturity: Medium to long-term, commonly 5-10 years.
  • Interest: Offer fixed or floating interest. Often higher than G-Secs.
  • Taxation: Interest is generally taxable. Some older issues might be tax-free.

Examples of Issuers:

• Power Finance Corporation (PFC) Bonds
• Rural Electrification Corporation (REC) Bonds
• National Highways Authority of India (NHAI) Bonds
• Indian Railway Finance Corporation (IRFC) Bonds
• Housing and Urban Development Corporation (HUDCO) Bonds

5. Tax-Free Bonds

Tax-Free Bonds are specific bonds. Government-backed entities issue them. They usually finance infrastructure projects. The key feature is their tax treatment. Interest earned on these bonds is completely tax-exempt. Section 10 of the Income Tax Act covers this.

• Features:
  • Issued by: Government-backed entities (e.g., NHAI, REC, IRFC).
  • Safety: Very high safety. Issued by government entities.
  • Purpose: Fund large infrastructure projects.
  • Maturity: Long-term, typically 10, 15, or 20 years.
  • Interest: Interest is tax-free. Coupon rates are usually lower.
  • Taxation: Interest is fully tax-exempt. Capital gains on early sale are taxable.

Examples of Issuers (past issuances, now traded in secondary market):

• NHAI Tax-Free Bonds
• REC Tax-Free Bonds
• PFC Tax-Free Bonds
• IRFC Tax-Free Bonds
• HUDCO Tax-Free Bonds

Understanding these bond types helps investors. They can select options based on risk appetite. They also match their investment goals. Bonds offer diverse benefits. They provide income and portfolio diversification.