The bond market

Bonds explained: government securities, corporate bonds, how price and yield move in opposite directions, what duration measures, and how to buy them in India.

A bond is a debt security: the investor lends money to an issuer, and the issuer is expected to repay it under the bond’s terms. The investor is the lender, not a co-owner, so there is no share in the business and no claim on its profits.

A conventional fixed-rate bond generally promises periodic coupon payments and repayment of principal at maturity, subject to the issuer meeting its obligations. Not every bond works that way. Some carry floating coupons, some pay no periodic coupon at all, some repay principal in instalments, and some have no fixed maturity.

Bonds are often treated as less volatile than equities, but that is a comparison, not a guarantee. Risk varies widely with the issuer, the maturity, the structure, how liquid the bond is and what the market is doing. Every bond investor faces four broad risks: credit risk, interest-rate risk, liquidity risk and inflation risk.

What a bond is made of

• Face value (FV): the principal amount used to calculate coupon payments, and generally the amount repaid at maturity for a conventional bullet bond.
• Coupon rate: the contractual interest rate, usually quoted annually as a percentage of face value.
• Coupon frequency: how often interest is actually paid. Annually, semi-annually or quarterly are all seen.
• Maturity date: when the remaining principal falls due under the bond’s terms.
• Market price: what the bond trades at in the secondary market.
• Yield: a measure of return derived from the price paid and the cash flows expected.

The three structures you will meet most often:

• Fixed-rate: one coupon rate, set at issue and unchanged for the life of the bond.
• Floating-rate: the coupon resets periodically against a benchmark, so the income moves with rates.
• Zero-coupon: no periodic coupons, sold below face value and redeemed at face value. The return is the difference.

Other structures exist, including amortising bonds that repay principal in instalments and perpetual bonds with no fixed maturity.

Primary and secondary bond markets

The primary market is where issuers raise money by issuing new debt securities to investors. Government-security auctions and new corporate-bond issues are both primary-market events. The issuer receives the proceeds from a new issue, subject to the issuance structure and costs.

The secondary market is where investors trade existing bonds with each other. A bond bought there may trade above or below face value, depending on prevailing yields, credit quality, liquidity and market conditions. When an existing bond is resold between investors, the issuer generally receives nothing; the money goes to the selling investor.

Coupon rate, current yield and yield to maturity

These get mixed up constantly, and they are not interchangeable.

Coupon rate fixes the contractual interest. For a conventional fixed-rate bond:

Annual coupon = face value × coupon rate

A bond with a face value of ₹1,000 and a 9% coupon pays ₹90 a year. The coupon rate stays fixed even as the market price moves.

Current yield compares that coupon income against what you actually paid:

Current yield = annual coupon ÷ purchase price × 100

Same bond, three purchase prices:

The coupon is still ₹90 in every row. What changes is the price you paid, so the yield on that price changes. Note what current yield leaves out: it ignores any capital gain or loss between the price you paid and the amount repaid at maturity. It is not a complete return figure, which is why it must not be used as one.

Yield to maturity (YTM) is the fuller measure. It is the annualised discount rate that makes the present value of the bond’s remaining contractual cash flows equal to its purchase price. In plain terms it accounts for the price you paid, the remaining coupons, the principal expected at maturity and the time left.

For a conventional fixed-rate bond with positive coupons, no embedded options and repayment at face value:

• Buying below face value means YTM is generally above the coupon rate.
• Buying above face value means YTM is generally below the coupon rate.
• Buying at face value means YTM is generally equal to the coupon rate.

Those relationships assume a plain conventional bond. They do not hold universally across every debt instrument.

A quoted YTM is also not a promise of realised return. What you end up earning depends on actually receiving the promised cash flows, how long you hold, and what you can reinvest at afterwards.

Why bond prices move

This is the single most useful thing to understand about bonds. For conventional fixed-rate bonds, all else being equal:

Yields rise → prices fall. Yields fall → prices rise.

The reason is competition. If new bonds are being offered at higher yields, an existing bond paying a lower fixed coupon becomes less attractive at its current price. Its price falls until its yield is competitive again. When market yields decline, the reverse generally happens.

A 10-year bond, face value ₹1,000, 8% annual coupon, priced to yield:

Duration

Duration measures how sensitive a bond’s price is to a change in yield. It is not the number of years until maturity, and maturity alone does not determine it: duration depends on the remaining cash flows, the coupon structure, the maturity and the yield.

Modified duration turns that sensitivity into an approximate percentage price change for a small change in yield. A bond with a modified duration of 5 would be expected to fall about 5% in price if its yield rose by 1 percentage point, using a first-order approximation.

That estimate is a first-order approximation. It ignores convexity, so it becomes less accurate for larger yield changes. The 10-year bond above has a modified duration of about 6.7: a 1-point rise in yield predicts roughly a 6.7% fall, while the actual move from ₹1,000 to ₹936 is 6.4%. The difference is the second-order effect.

Otherwise comparable longer-maturity bonds generally have greater interest-rate sensitivity, because more of their cash flows sit further out and are discounted more heavily.

Government securities in India

Government securities are debt instruments issued by the Central Government or, in the case of SDLs, by State Governments. RBI manages government borrowing and runs the relevant auctions and settlement operations under the applicable framework, but it is not generally the borrower itself.

Central Government dated securities have specified maturities. Many pay fixed coupons, commonly semi-annually, though floating-rate and other permitted structures also exist. These are the benchmark instruments against which other rupee debt is priced.

Treasury Bills (T-Bills) are short-term Central Government instruments with original maturities of 91, 182 and 364 days. They are generally issued at a discount to face value and redeemed at face value, rather than paying periodic coupons.

State Development Loans (SDLs) are issued by State Governments. Their yields can differ from comparable Central Government securities because of differences in liquidity, demand and supply, so they are not simply the same thing under another name.

Sovereign Gold Bonds (SGBs) are a separate category whose redemption value is linked to gold prices, with additional contractual interest under the scheme terms. Because gold-price movements are a major driver of returns, an SGB is not a conventional fixed-income bond. Note also that no fresh SGB issues have been announced: the last tranche was 2023-24 Series IV in February 2024, and RBI now publishes redemption calendars for the existing outstanding bonds rather than opening new subscriptions.

Government securities and risk

Central Government securities denominated in rupees are commonly used as benchmark instruments and are generally regarded as having very low domestic-currency sovereign credit risk. They are not risk-free in every sense. Investors can still face interest-rate risk, market-price risk, inflation risk, liquidity risk and reinvestment risk. Their yields matter mainly because so many other instruments are priced off them.

Corporate bonds

Companies issue bonds and debentures to borrow money from investors. The interest rate, repayment terms, security arrangements and other conditions depend on the instrument.

Secured bonds are backed by specified assets or security interests, subject to the applicable legal arrangements. Unsecured bonds have no collateral behind them. Secured is not the same as safe: recovery depends on the quality of the collateral, whether it can be enforced, where the instrument ranks and what it is actually worth.

Senior debt generally ranks ahead of subordinated debt in the issuer’s repayment hierarchy, subject to the specific terms and applicable insolvency law.

Credit ratings are independent assessments of an issuer’s or instrument’s creditworthiness by recognised rating agencies. On a typical long-term scale, AAA is the highest credit-quality category and lower ratings indicate greater assessed credit risk. Broadly, investment-grade and speculative-grade categories separate lower from higher credit risk. Two things are easy to forget: ratings are opinions, not guarantees of repayment, and they can be raised or lowered. A AAA-rated bond can still default.

Corporate bonds often yield more than comparable government securities. That difference is the yield spread, and it can reflect credit risk, liquidity, maturity and structural differences, tax treatment, market demand and supply, and other instrument-specific factors.

A high coupon or a high yield is not a gift. It is usually the market pricing something, and that something is the reason to read the terms before buying.

The yield curve

The yield curve plots yields against maturities for comparable instruments, usually government securities. Three shapes are common:

• Normal or upward-sloping: longer maturities yield more than shorter ones.
• Flat: yields across maturities are broadly similar.
• Inverted: shorter maturities yield more than longer ones.

The shape reflects interest-rate and inflation expectations, term premiums, and demand and supply. An inverted curve is often discussed in relation to growth and rate-cut expectations, but it is not a signal that guarantees a recession or any other specific outcome. Reading it properly is a bigger topic than this lesson needs.

How to buy bonds in India

Eligible investors reach bonds through several different channels, and they are not interchangeable.

RBI Retail Direct lets eligible retail investors open a Retail Direct Gilt account and participate in permitted primary government-security auctions, and in secondary-market transactions in eligible government securities. That secondary access runs through NDS-OM, RBI’s order-matching system. The official platform is rbiretaildirect.org.in.

Brokers and exchanges allow certain listed debt securities to be traded, subject to eligibility, trading arrangements and availability. Not every bond has enough secondary-market liquidity to trade at a fair price.

Online Bond Platform Providers (OBPPs) are SEBI-registered entities, registered with NSE and BSE, offering another route to eligible debt securities. SEBI publishes a list of them. Check a platform’s registration before using it, and understand the instrument before you buy anything on it.

New corporate-bond issues can be subscribed directly by eligible investors under the applicable offer terms.

One distinction worth keeping: not every government-backed savings instrument behaves like a marketable dated security. Floating Rate Savings Bonds, 2020 (Taxable), for example, are held in a bond ledger account and, under the RBI’s terms, are neither transferable beyond a nominee or legal heir nor tradable in the secondary market. Check the current terms of any specific scheme.

Accrued interest: clean and dirty price

Between coupon dates, interest accumulates. A quoted bond price may exclude it.

• Clean price: the quoted price, excluding interest accrued since the last coupon payment.
• Dirty price: the clean price plus that accrued interest.

On a coupon-bearing bond, the buyer may pay the dirty price between interest dates, depending on the market’s settlement and quotation conventions. It is a presentational difference, not an extra cost.

Risks of bond investing

Interest-rate risk. Prices generally fall when market yields rise, most of all for conventional fixed-rate bonds.

Credit or default risk. The issuer may fail to make scheduled interest or principal payments.

Liquidity risk. A bond may be hard to sell quickly at a reasonable price when trading activity is thin.

Inflation risk. Inflation can reduce what your future coupons and principal are actually worth in purchasing power.

Reinvestment risk. Coupons may have to be reinvested at rates lower than you expected.

Call or early-redemption risk. Some bonds let the issuer redeem them before the stated date under set conditions, which can affect your expected return and your reinvestment options.

Holding a conventional fixed-rate bond to maturity and receiving every promised payment generally means you never realise the interim price swings. That is real, and it is why the strategy exists. But it does not remove default risk, inflation risk, reinvestment risk on the coupons, or the effect of special redemption terms. Holding to maturity is not a guarantee of repayment or of any particular return.

Next: the forex market.