About Bonds
Conventional Bonds
A bond is a fixed income instrument which offers its holder the fixed amount of interest known as coupon at a periodic rate (3m, 6m, yearly etc) and the return of the principal amount known as face/par value at the maturity. A bond is a debt or promise to pay investors interest payments along with the return of invested principal in exchange for buying the bond.
Tenure of a bond instrument can range 1 to 30 years. Perpetual bonds have no maturity date. Issuer of the bonds issues bonds to raise finances to meet its expenditure needs.
Bonds can be classified into different kinds depending on their tenure, issuer types, returns etc. Some of these major classifications are mentioned below.
Issuer of the bonds can be a govt entity or a private corporation or a govt enterprise. When bonds are issued by govt they are called G-Secs (Govt Securities), these bonds are considered risk-free as they are backed by the state govt or central govt itself. Interest rates on bonds (coupon rate) is a function of the risks embedded in a bond. Risk-free bonds issued by the government carry the lowest rate of interest. Bonds issued by private corporations are considered riskier as the private companies can go bankrupt, hence these bonds carry higher rates of interest/coupon to compensate for the higher risks.
In case of bonds issued by private companies, bonds carry a right on the assets of the company. In the event of bankruptcy of the issuer, assets are liquidated, and bondholders get the amount from the sales proceeds as per their rights on the assets. Some bonds carry higher rights (primary), other type of bonds carry lower rights (secondary). Claims are first settled for the bondholder carrying higher charge.
In the capital structure (consisting of bonds, equity share etc) of a company a bond carries higher charge than the equity share. Hence, between a bond and an equity share, bond is considered a less risky investment than an equity share. In the case of liquidation, proceeds first go to the bondholders and then equity shareholders are given the remaining proceeds.
The bond market in India assumes two distinct forms—primary market and secondary market. In Primary Market, the company issue bonds which are of a sizeable amount which restricts retail investors (like you and me) to invest. Only institutions and wholesalers participate in it.
Some bonds are listed on exchanges and hence they trade freely in the secondary markets. The secondary market facilitates the trading of bonds bought in the primary market. Prices of bonds are highly sensitive to the market rate of interest (interest rate set by the RBI). Market prices fluctuate as per the prevailing market rate of interest. If the market rate of interest and the coupon rate is the same, then the market price of a bond and par value of a bond will be the same. Price of a bond is inversely related to the market interest rates – if interest rates go up then market price of a bond goes down and vice-versa. Reason is simple, bonds carry fixed rates of interest and if the market interest rate goes up then the attractiveness of a bond deteriorates leading to decline in bond prices and vice-versa. Please note par value remains the same, it does not change. On maturity, bond is always redeemed at its par value.
Covenants in a bond
Covenants are clauses specifying the rights of the bond holders and restrictions on the bond issuers. Covenants are broadly of two kinds: Positive covenants and Negative covenants. Positive covenants are actions issuers are required to do, whereas negative covenants specify what issuers are prohibited from doing. These are necessary to protect an investor’s investment in the debt security.
Bond Indices
Just as the S&P 500 and the Russell indices track equities, big-name bond indices like the Bloomberg Aggregate Bond Index, the Merrill Lynch Domestic Master, and the Citigroup U.S. Broad Investment-Grade Bond Index track and measure corporate bond portfolio performance. Many bond indices are members of broader indices that measure the performances of global bond portfolios.
Ratings
Every issuer must get itself rated for the bonds that it issues from rating agencies. These agencies determine the degree of ability and willingness of the issuers to meet their financial obligation in a timely manner.
Corporate bonds are typically classified as either investment-grade or else high-yield (or "junk"). This categorization is based on the credit rating assigned to the bond and its issuer. An investment-grade rating signifies a high-quality bond that presents a relatively low risk of default. Bond-rating firms like Standard & Poor’s and Moody's use different designations, consisting of the upper- and lower-case letters "A" and "B," to identify a bond's credit quality rating.
Junk bonds are bonds that carry a higher risk of default than most bonds issued by corporations and governments. These bonds are typically issued by corporates having very high risk of default because of their weak balance sheet. Junk bonds represent bonds issued by companies that are financially struggling and have a high risk of defaulting, or not paying their interest payments or repaying the principal to investors. Junk bonds are also called high-yield bonds since the higher yield is needed to help offset any risk of default. These bonds have credit ratings below BBB- from S&P or below Baa3 from Moody's.
Bonds Markets in India – Size
The bond market in India, today, stands at around $1.8 trillion, which is further split into $1.2 trillion for government securities and $0.6 trillion for corporate bonds[1]. The corporate bond market has seen a rise in its market size from 18%-20% in the recent past. Infact the Indian Govt is aggressively planning to raise funds to fuel its infrastructure projects through retail investors by leveraging debt markets, from the recent parliamentary discussions the govt is planning to raise the money to the tune of Rs 43.6 lakh crores for its infrastructure projects.
The Indian Govt. has taken several measures to grow the size of bonds market in India, these include issuing several sovereign bonds in the recent past to raise funds, bringing down the initial prices of the bond from 10 Lakhs to 1 Lakh, to encourage more participation from retail investors in the market
Companies seeking finance have two main routes: equity financing or debt financing. Equity financing requires giving up a percentage of ownership in the company (like selling shares). Debt financing requires eventually paying back the funds over an agreed period plus regular interest payments.
Companies pursuing debt financing have two main paths: a loan from a bank or other financial institution. Or issuing bonds. Bonds are like an I-Owe-You that can be traded by investors (bondholders). They have an agreed time period (often 10 years) after which the bond has matured and the value is repaid to the bondholder. Over the course of that period regular interest payments are paid by the bond issuer to the bondholder. This is called the coupon (coupon rate = the interest rate of the debt).
Though larger than the global stock market, the bond market is far more opaque, with fewer checks and balances, and huge power vested in a small number of players. As many banks start to limit their lending to carbon intensive industries, companies in the coal, oil and gas value chain are turning more to the bond market as a safe haven. By issuing bonds they can enjoy less public scrutiny, less transparency and ready access to trillions of dollars of debt. Accessing this cheap debt relies upon a chain of financial institutions: investment banks, ratings agencies and investors.
Thematic Bonds
Since 2008, a variety of thematic bonds are being issued on different themes which enable investment in specific areas some of which are given below:
Green Bonds
Green bonds are the most established part of the ESG bond market. The proceeds of these bonds finance environmentally-friendly projects such as renewable energy projects or electric vehicle charging stations. Last year saw green bond issuance of as much as $182 billion, including some inaugural emerging market (EM) issuers like Egypt (which became the first country in both Africa and the Middle East to issue a dollar sovereign green bond). Such issuance from EM and high yield issuers adds welcome diversity to the green bond universe, which is still tilted to highly-rated issuers, predominantly banks and utilities. Click here to read more about Green Bonds
Social Bonds
Sustainability Bonds
Transition Bonds
Blue Bonds
Blue bonds are a subset of green bonds, those used specifically to finance projects related to ocean conservation. This includes managing plastic waste, but also promoting marine biodiversity by ensuring sustainable, clean and ecologically-friendly developments. As with green bonds, blue bonds follow the associated ICMA principles. Click here to read more about Blue Bonds
Sustainability - Linked Bonds
Sustainability-linked bonds (SLBs) work somewhat differently in the sense that there are no restrictions on the use of proceeds. What matters here is the company’s meeting certain predefined sustainability targets which can be related to environment or social aspects. Hence, it is an approach that moves away from specific activities and puts in focus the sustainability performance of an issuer. The coupon of sustainability-linked bonds is linked to some sustainability performance indicators – not meeting the sustainability commitments would result in a coupon step-up.
Key Players
Bond investments require a number of key players to facilitate the operation of the bond. Some of these are listed below:
Bond Issuers
Bonds are issued by a company for general operations, to refinance other debt, or to fund capital intensive projects or acquisitions and companies have to pay periodic interests to the buyers while paying back the buyers in full within the maturity dates to avoid default. Issuing bonds is attractive to fossil fuel companies because:
Bookrunners, Arrangers or Underwriters
To issue a bond, a company needs a dealmaker. Often several. Banks, act as a bookrunner (also known as an arranger or underwriter), Banks advise companies issuing bonds and help take them to market the bonds. As calls for climate action and sustainable finance are getting louder, many large banks have developed net zero and/or coal exclusion policies. But in some cases these policies apply only to the investment activities of the bank, not financial services like bookrunning. Any bank supporting expansionist fossil fuel companies is driving climate chaos. The Toxic Bonds campaign asks that all banks urgently cease underwriting Toxic Bonds.
Credit ratings agencies
For a bond to be issued, the credit worthiness of the issuer needs to be rated. Just three agencies dominate this business - S&P, Moody’s and Fitch. They tell potential investors how risky a bond is. The lower they deem the risk, the cheaper and easier it becomes for companies to secure debt.