Corporations and Governments issue bonds when they are looking to borrow money from investors for specific projects – for instance to expand production, finance expenditures, or build a road. A bond is a loan – a structured IOU – and when you purchase a bond, you are taking on the role of a lender, not a shareholder or owner in the company. Just like any loan, specific terms apply. When a bond is issued, the corporation or government specifies the amount of the loan (called the face value), the term of the loan (called the maturity), the interest payment to be paid every year (called the coupon), and if any other provisions, like being able to pay the loan off early, (called a put provision) are related to it. For instance, you could buy a bond with a $1,000 face value, a 5% coupon and a 10-year maturity. As an investor, you would collect interest payments totaling $50 in each of those 10 years, and at the end of that period when the 10 years were up, you'd get back your $1,000 back. Even though most of the bonds are interest-bearing there are some which are called discounted securities or zero coupon bonds that do not pay regular interest at intervals but are bought at a discount to their face value. Bonds can be categorized based on various criteria.
A key difference between a stock and a bond is that stocks make no promises about paying out their earnings through dividends. Nor do stocks guarantee that you will be able to maintain the value of your original investment.
- Government securities (Also called Gilt)
- Corporate Securities or Financial Institution Bonds
- Maturity Profile of Short term or Money Market securities (less than one year)
- Debt securities (longer than one year)
- Credit Rating Profile
- AAA/AA/A/BBB/BB/B/C/D (Descending order of credit quality for medium and long term securities)
- PR1/PR2/PR3/PR4/PR5 (Descending order of credit quality for short term securities)
When ICICI issues a bond, however, the company guarantees to pay back your principal (the face value) plus interest. If you buy the bond and hold it to maturity, you know exactly how much you're going to get back. That's why bonds are also known as "fixed-income" investments -- they assure you a steady payout or yearly income. And although they can carry plenty of risk (we'll discuss why in 'How Bonds Behave article'), this regular income is what makes them inherently less volatile than stocks.