Question

Write a short note on types of Bonds.

Answer 1

Bonds are issued by organizations generally for a period of more than one year to raise money by borrowing. Organizations in order to raise capital issue bond to investors which is nothing but a financial contract, where the organization promises to pay the principal amount and interest (in the form of coupons) to the holder of the bond after a certain date. (Also called maturity date).Some bonds do not pay interest to the investors, however, it is mandatory for the issuers to pay the principal amount to the investors.

(A) Based on coupon/interest

1. Fixed rate bonds: -

Fixed rate bonds have the coupon that constant throughout the life of the bond.

2. Floating rate bonds: -

These bonds have a variable rate of interest. Interest rates are recalculated periodically.

3. Zero-coupon bonds: -

No coupons are paid to zero-coupon bonds. The bond is issued at discount. On maturity, these bonds are redeemed at par. The difference between the acquisition cost of bond and face value of a bond is profit to investors.

4. Deep Discount bonds: -

These bonds are similar to zero-interest bonds but have a huge discount and a long period of maturity i.e. 25 years and more. These bonds are not entitled to any interest. The difference between cost and maturity value is profit for the investor.

5. Inflation-indexed bonds: -

The principal amount of bond and the interest payments are indexed in inflation. The principal amount grows and payment of interest increases with inflation.

6. Perpetual Bonds:

Bonds with no maturity dates are called perpetual bonds. Holders of perpetual bonds enjoy interest throughout.

7. Subordinated Bonds:

Bonds which are given less priority as compared to other bonds of the company in cases of a close down are called subordinated bonds. In cases of liquidation, subordinated bonds are given less importance as compared to senior bonds which are paid first.

(B)    Based on option

1. Bond with call option (callable bonds: -

This feature gives the right to the issuer, the right to redeem his issue of bonds before the maturity of bonds at the predetermined price and date.

2. Bond with a put option (put table bond): -

This feature gives bondholders the right to sell their bonds back to the issuer at the pre-determined price and date.

3. Embedded Options in Bonds:

Bond call and put options are also used to refer to the option-like features of some bonds. A callable bond has an embedded call option that gives the issuer the right to “call” or buy back its existing bonds prior to maturity when interest rates decline. The bondholder has, in effect, sold a call option to the issuer. A puttable bond has a put option that gives bondholders the right to “put” or sell the bond back to the issuer at a specified price before it matures.

(C)    Based on Redemption

1.Bonds with single redemption: -

In this case, principal amount of bond is paid at the time of maturity only.