What are Bonds? and Types of Bonds in Finance

What are Bonds?

Bonds are basically the debt instruments used by governments and businesses to borrow money from the public. It is a legal agreement between the lender and borrower that promises to pay back the principal amount with interest to the bondholders. If you buy a bond that means you are lending your money to the government or businesses at a specified interest rate which may be a floating or fixed interest it depending on the type of bond you have.

Simply, we can say that if a company and government need money to complete their project and operations then they will issue bonds to the public to borrow money from them, and in return, they receive a regular interest payment which is known as coupon payments at a specified period.

Types of bonds in finance

• Corporate Bonds
• Government Bonds
• Municipal Bonds
• Zero-Coupon Bonds
• Perpetual bonds
• Convertible Bonds
• Non-Convertible Bonds
• Callable Bonds
• Putable Bonds
• Floating-Rate Bonds
• Fixed-Rate Bonds
• Inflation-Protected Bonds

Corporate Bonds

Corporate bonds are those bonds which are issued by the companies to raise money from the public. If any company needs money to expand their businesses then they will issue corporate bonds to get loans from the public and the issuer pays the interest regularly to the bondholder/investor.

Government Bonds

Government bonds are those bonds that are issued by the national government to raise funds from the public. The government issues bonds for various purposes like funding projects, improving infrastructures, managing national debt, etc., and more. This type of bond is safe as compared to other bonds because they are backed by the government.

Municipal Bonds

Municipal Bonds are those bonds where the state or local government is involved in raising funds from the public. They use those funds to improve infrastructures like roads, Water supply, bridges, Airports, Hospitals, and other facilities. The bondholders will receive periodic interest payments from the local government.

Zero-Coupon Bonds

Zero-coupon bonds are a type of bond that does not have any interest payment. This type of bond is issued at a discount to its face value which means the issuer issued this bond at a discount rate, suppose a corporation issues $1000 bonds at a 25% discount rate which is $750. So you will get a 1000-dollar bond at 750 dollars and if you hold it to the maturity you will receive the actual value of the bond which is $1000.

Perpetual Bonds

Perpetual bonds are a type of bond that does not have a maturity which means the bondholders never receive their principal amount back, as there is no scheduled repayment of the principal amount. But instead of their capital amount, they will get periodic interest payments. Generally, these types of bonds were issued by governments and large corporations.

Convertible Bonds

Convertible Bonds are those bonds that can be converted into equity shares. These types of bonds are generally issued by the companies or not by the government because these bonds allow bondholders to convert their bonds into equity shares, the government does not have the structure of equity shares. In a convertible bond, the bondholders can only be able to convert that debt into shares of the issuing company which is the issuer of the bond.

Non-Convertible Bonds

Non-convertible bonds are a type of bond where there is no option to convert the bond into equity shares. This is a normal type of bond where the bondholder will receive a fixed interest payment until maturity. The main thing is the Issuer does not provide you the facility to convert your bond into equity shares.

Callable Bonds

Callable Bonds are those bonds that allow issuers to redeem the bonds before maturity. In this type of bond, the issuer has the right to redeem or repurchase the bond early so that the issuer can easily manage the interest rates fluctuations and potentially reduce the cost of borrwing. Callable bonds mainly beneficial for the issuer so that the issuer can manage their cost by repuchase or buyback the bonds from the bondholders, But that does not mean the bondholder do not get the benefit, they get the higher interest rates as compared to non-callable bonds. As it can be redeem earlier, the bondholder may receive a call premium from the issuer if they buyback from you.

Putable Bonds

This type of bond is mainly focused for the bondholder where the holder has the right to sell their bond to the issuer before the maturity which is totally opposite from the callable bonds. This type of bonds help bondholders to protect themselves against rising interest rate and allow them to exit from the their investment and reinvest in potentially higher rates. Putable bonds were issued at a lower interest as it provide more flexibilty to the bondholders.

Floating-Rate Bonds

Floating rate bonds are those bonds which the interest rate are based on the market interest rates. It fluctuate periodically according to changes in market interest rate. If the currrent market interest rate is 8% then your bond will give you the payment according to 8% interest rate, if the the interest rate changes from 8 to 12% then the payment you will get according to 12%. This is basically a floating rate bonds.

Fixed-Rate Bonds

Fixed-Rate bond are those bonds that have fixed interest rate which means it will remains constant until the maturity. For example, if the bond’s fixed rate is 11% while the current market rate is 9%, you benefit from the higher rate. However, if market rates rise to 12%, the bond’s price may fall. This is basically known as Fixed-Rate-Bonds.

Inflation-Protected Bonds

Inflation-Protected Bonds are a bonds that protect the bondholder from the inflation. This type of bond will provide you the interest rate according to the inflation rate. If the inflation rate increases the principal and interest of the bond will also increase.