Bond is an instrument of indebtedness of the bond issuer to
the holders. These are a kind of fixed income securities. Depending on the terms
and conditions of the bond, interest is paid to the holder. The principal is
repaid on a date that’s called the maturity date. The ownership can be
transferred in the secondary market. These are more secure because here we have
guaranty of repayment of principal.
Types of bonds
Fixed income securities are
generally classified on the basis of the time frame/ maturity period.
Bills: fixed income securities that have a maturity period of one
year.
Notes: fixed income securities that have a maturity period between
one to ten years.
Bonds: fixed income securities that have a maturity period of more
than ten years.
Government bonds: These are issued by the government authorities
and are as safe as the debt of a stable country. They are free from state and
local taxes on the interest payments.
Municipal bonds: these are the next in matters of risk after
government bonds. They are also called as “munis”. The main advantage of such
bonds Is that the returns are free from federal taxes. These are very good tax
saving instruments. Local governments may sometimes make their debts tax free
for the residents leading to tax free municipal bonds.
Corporate bonds: these are bonds that are issued by the company to
raise capital. There is no limit as such. These give higher yields than a
government bond because they have a higher risk of defaulting than a
government. The driving factor in case of these bonds is the credit quality.
The higher the credit quality the lower is the interest rate. Corporate bonds
can also be convertible is nature. The holder can get them converted into
stocks or callable bonds.
Zero Coupon Bonds: This is bond that does not have coupon payment
but I issued at a discount to par value.
Trading
Retail Debt Market: NSE has introduced a new and simpler way of
investing in bonds and fixed income securities. The retail investors can buy
and sell government securities from different locations through NSE brokers and
sub brokers in the same manner as trading of equities is done. This market is
known as “Retail Debt Market”.
Wholesale Debt Market: It provides a trading platform for a wide
range of debt products.
It is a market where corporate bonds, government bonds,
municipal bonds, negotiable certificates of deposit, and various money market investments
are traded.
Bond duration
A bond’s duration represents the
weighted average time to full recovery of Interest and principal payments.
There are four main types of bond
duration calculations which are as follows:
1)Macaulay duration: Macaulay duration is calculated by adding
the results of multiplying the present value of each cash flow by the time it
is received and dividing by the total price of the security. The formula for
Macaulay duration is as follows:
 n = number of cash flows t = time to maturity C = cash flow i = required yield M = maturity (par) value P = bond price |
2)modified duration: Modified duration is a modified version of the
Macaulay model that accounts for changing interest rates. Because they affect
yield, fluctuating interest rates will affect duration, so this modified
formula shows how much the duration changes for each percentage change in
yield.
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3)
Effective duration: The modified duration formula discussed above assumes
that the expected cash flows will remain constant, even if prevailing interest
rates change; this is also the case for option-free fixed-income securities. On
the other hand, cash flows from securities with embedded options or redemption
features will change when interest rates change. For calculating the duration
of these types of bonds, effective duration is the most appropriate.
