A bond is a loan in tradable form. The issuer — a government, a public-sector body or a company — borrows money and promises to pay interest at set intervals and repay the principal on a fixed date. Because bonds can change hands before that date, their prices move, and that is where most of the confusion begins.
The building blocks
| Term | What it means |
|---|---|
| Face value | The amount the issuer repays at maturity, often ₹1,000 or ₹1 lakh per bond |
| Coupon | The annual interest rate on face value, paid yearly, half-yearly or at other intervals |
| Maturity | The date the principal is repaid |
| Price | What the bond trades for today — above face value (premium) or below it (discount) |
| Yield | The return implied by the price you pay |
A worked example
For illustration, take a bond with ₹1,000 face value, an 8% annual coupon and five years to maturity. It pays ₹80 a year and ₹1,000 at the end.
| Price you pay | Current yield | Yield to maturity |
|---|---|---|
| ₹950 (discount) | about 8.42% | about 9.30% |
| ₹1,000 (at par) | 8.00% | 8.00% |
| ₹1,050 (premium) | about 7.62% | about 6.79% |
At ₹950, the ₹80 coupon is a larger share of what you paid, so the current yield is higher. And because you receive ₹1,000 at maturity for a bond bought at ₹950, you also gain ₹50 over five years. YTM includes that gain, so it is higher still.
At ₹1,050 the reverse happens: the coupon is a smaller share of the price, and you lose ₹50 by maturity, so YTM falls below the coupon.
A quick approximation of YTM:
YTM ≈ [annual coupon + (face value − price) ÷ years] ÷ [(face value + price) ÷ 2]
For the ₹950 bond: (80 + 10) ÷ 975 ≈ 9.23%, close to the precise 9.30%. The Bond Yield & Cashflow tool calculates both and lays out every coupon and the final repayment.
Why price and yield move in opposite directions
The coupon is fixed when the bond is issued. If market interest rates later rise, new bonds offer higher coupons, so an existing bond paying less must trade at a lower price to offer a competitive yield. If rates fall, the existing bond's higher coupon becomes more valuable and its price rises. We explain this, and how to measure the sensitivity, in why bond prices fall when rates rise.
Accrued interest and the price you actually pay
Bonds trade between coupon dates. When you buy, you pay the seller the interest that has built up since the last coupon — accrued interest — on top of the quoted price, and you then receive the full next coupon. The price without accrued interest is the clean price; with it, the dirty price. Quotes are usually clean prices, so the amount debited can be higher than the quote.
Types of bonds you will meet
- Government securities (G-secs): issued by the central and state governments. They carry minimal credit risk, but their prices still move with interest rates.
- Corporate bonds and debentures: issued by companies and financial institutions. They pay more than comparable government bonds to compensate for credit risk; check the credit rating.
- Secured and unsecured bonds: secured bonds are backed by specific assets; unsecured bonds rely on the issuer's general ability to pay. Seniority affects what investors recover if something goes wrong.
- Zero-coupon bonds: pay no periodic interest; they are issued at a discount and repaid at face value.
Liquidity
Many bonds trade infrequently. Listed bonds can be sold on an exchange, but there may be few buyers on a given day, and selling quickly may mean accepting a lower price. If you might need the money before maturity, factor this in from the start.
Holding to maturity
If you hold a bond until maturity and the issuer pays as promised, interim price movements do not change what you receive: the coupons plus face value. Your return will then be close to the YTM at which you bought, provided coupons are reinvested at similar rates. What holding to maturity does not remove is credit risk — the issuer's ability to pay.
Tax in brief
Coupons are taxed at your slab rate. Gains on listed bonds held for more than 12 months are taxed at 12.5%; gains on unlisted bonds are taxed at slab rates. See how investments are taxed for details and the edition date. The Bond centre covers how bonds can fit into a wider plan.