Understanding Bonds, the Bond Market: Opportunities for Investments in the Indian Securities Market for Retail Investors
The bond market stands as the world's largest securities market, offering investors an extensive range of investment options. Initially perceived as a means of generating interest while safeguarding capital, bonds have transformed into a $100 trillion global marketplace that can provide numerous potential benefits to investment portfolios, including lucrative returns.
Objective: This article covers the legal framework of bonds in India, different types of bonds, the advantages and risks associated with bond investments, taxation aspects to be factored in, the different types of retail investor and their investing strategies, the tailwinds and headwinds for retail participation, and the role of Chartered Accountants in this securities market for retail investors.
Understanding Bonds
A bond is a financial instrument that facilitates borrowing between a borrower and a lender. It comprises three fundamental elements:
- Borrower / Issuer: The party that seeks to borrow funds.
- Lender / Investor: The party that provides the funds for borrowing.
- Financial Document: The formal document that outlines the terms and conditions of the bond.
What is the Bond Market?
A bond market is a place where the borrower/issuer and the lender/investor agree on the terms and conditions of the arrangement — like tenure, rate of interest, security, terms of repayment, etc. This arrangement gets documented in the form of a financial document providing legal acceptance of the terms and conditions. Basis the accepted terms, funds flow from the lender/investor to the borrower/issuer and vice versa. In a nutshell, the bond market serves as a platform for the movement of funds between the parties involved.
The bond market can be further bifurcated into two main segments:
- In the primary bond market, new bonds are issued.
- The secondary bond market provides liquidity by allowing investors to trade existing bonds.
Participants in the bond market include the government, institutions, and retail investors.
A bond market is a place where the borrower/issuer and the lender/investor agree on the terms and conditions of the arrangement, like tenure, rate of interest, security, terms of repayment, etc.
The Indian Bond Market — its process, legal framework, and benefits — can be encapsulated in the word "DREAM".
Demat and KYC Compulsory: For investment in a bond, a demat account and KYC of the investor is a mandatory requirement in the current setup.
Regulated and Structured Setup: The bonds are regulated by RBI and SEBI, providing legal status to the bond issuance and investment process.
Efficient Risk Management: Bonds enable efficient portfolio diversification and thus assist in portfolio risk mitigation.
Aligned with Goals: Different types of bonds are available and can be aligned with short-term / long-term goals of the investors.
Hold till Maturity: Bonds provide the best returns when held till maturity.
Regulated and Structured Setup
- Bonds derive their legality from the Securities Contracts (Regulation) Act, 1956 — specifically Section 2.
- Reserve Bank of India (RBI): Regulates and facilitates government bonds and other securities on behalf of governments. The Government Securities Act, 2006 (G S Act) relates to Government securities and is managed by the RBI.
- Securities and Exchange Board of India (SEBI): Regulates bond instruments and processes pertaining to listed corporations, commercial banks, and public sector undertakings.
The above two regulators broadly govern and regulate the bonds issued in the Indian market.
Bond Market — Need for Retail Investors
- Missing bridge between FDs / Debt MFs / other savings instruments & equity investments: There is a clear market gap for products offering returns between 8–12%.
- Limited investment options beyond equity: Investors can utilise bonds for trading and investment purposes, offering limited downside risk and enhanced returns.
- Challenges with investment in bonds via Debt MFs: Debt MFs offer easy investment and withdrawal, but incur high intermediary costs (3%–4%), reducing returns significantly.
- Challenges with bond market accessibility and understanding: Manual processes, limited availability of bonds, and high ticket size.
Advantages of Investment in Bonds
Four key advantages of investment in bonds for retail investors:
- Portfolio Diversification: Bonds are an efficient portfolio diversification instrument and assist investors in overall portfolio risk management.
- Regular Income Stream: Bonds provide investors a regular and steady source of income.
- Low Market Volatility: Bonds carry very low volatility compared to other investment assets like equity or mutual funds.
- Loan Against Bonds: Bonds are securities and considered assets, which can be pledged, and a loan can be availed by the investor for personal and business purposes.
Types of Bonds
Based on the type of issuers, bonds are classified into the following segments:
| Market Segment | Issuer | Instruments |
|---|---|---|
| A. Government Securities | Central & State Governments | Zero-Coupon bonds, Coupon-bearing bonds, Treasury bills, STRIPS, State Development Loans |
| B. Public Sector Bonds | Government Agencies / Statutory bodies | Govt. Guaranteed Bonds and debentures, Municipal debt securities |
| Public Sector Units | Bonds, Commercial Paper | |
| C. Private Sector Bonds | Banks | Certificate of Deposits, Bonds, Structured Instruments, Perpetual bonds |
| Financial Institutions | Certificate of Deposits, Bonds, Structured Instruments, Commercial Paper |
I. Government Securities
These bonds are issued by the Central Government or the State Governments to fund financial requirements. They are considered most safe and practically risk-free, due to the sovereign backing of the issuing government.
| Benefits | Key Features |
|---|---|
| High liquidity in secondary markets | Safety: Highest (Sovereign) |
| Wide range of tenors available | Issuers: Government of India, State Governments (SDL) |
| G-Secs can be used as collateral for equity derivatives | Tenure: 91 days – 40 years |
| Buy and sell anytime in secondary markets | Fixed Returns: Yield to Maturity 6–8% p.a. | Minimum Investment: INR 100 |
II. State Guaranteed Bonds
These bonds are issued by state-owned corporations and are guaranteed by the state government. Since they are backed by the creditworthiness of the state, there is an extra layer of security for investors.
| Benefits | Key Features |
|---|---|
| High safety due to state guarantee | Safety: High Safety — AA/A rating |
| Higher returns than Government Bonds | Issuers: State-owned entities such as U.P. Power Corporation, Kerala Infrastructure Investment Fund, etc. |
| Tax benefit in certain jurisdictions | Tenure: 5 – 10 years |
| Fixed Returns: Yield to Maturity 8.5 – 10% p.a. | Minimum Investment: INR 1 lac |
III. Corporate Bonds
Companies raise money by taking loans, issuing equity, and also by issuing corporate bonds. These bonds are purchased by investors, who then receive regular interest and principal payments from the issuing corporate entity.
| Benefits | Key Features |
|---|---|
| Large universe of >10,000 bonds giving a wide selection of issuers, returns, maturity, rating, and payment frequency | Safety: Investment grade — Credit rating AAA/AA/A/BBB |
| Buy and sell anytime in secondary markets | Issuers: Over 1,000 Corporations |
| Tenure: 1 – 10 years | |
| Fixed Returns: Yield to Maturity 8–14% p.a. (Investment Grade) | Minimum Investment: INR 1,000 |
With different entities borrowing money for their respective businesses, the interest rates are subject to a great degree of variation by virtue of several issuer-specific and non-specific factors. Generally, corporate bonds carry a higher rate of interest than government bonds, and that is the primary reason for considering investment in corporate bonds.
Companies raise money by taking loans, issuing equity, and also by issuing corporate bonds. These bonds are purchased by investors, who then receive regular interest and principal payments from the issuing corporate entity.
Bond Market — Potential
Bank Deposits
INR Lakh Cr · As on March 2025
- FDs — 136 (60%) · 5–7% returns
- Savings — 68 (30%) · 0–3% returns
- Other — 10% · 0% returns
Bond Market
INR Lakh Cr · As on March 2025 · 8–11% returns
- Outstanding Bank Deposits — INR 227 Lakh Cr (Source: RBI)
- Bonds Outstanding — INR 238 Lakh Cr (~ $2.78 trillion)
- Growing at a CAGR of 20%, expected to double every 3.5 years
- The bond market is almost 2/3rd of GDP & the equity market, and is expected to become larger than the equity market
- Retail investment in bonds is still negligible — a market of ~70 cr PAN holders
- Vs global peers, India's bond market stands at 0.65x of equity market capitalisation, compared to 1.2–2.0x in developed countries
Bond Ratings by Credit Agencies
Bond ratings determine the creditworthiness of a bond issuer. These ratings provide insight into whether the issuer can meet the terms of the bond agreement, including timely repayment of the principal and interest.
SEBI (Issue and Listing of Non-Convertible Securities) Regulations, 2021 makes it mandatory for the issuer to obtain at least one credit rating from the registered credit rating agencies and disclose the same in the offer document. If ratings are obtained from multiple agencies, all ratings — including unaccepted ones — must be disclosed.
Bond ratings range from AAA (highest creditworthiness) to D (default). In India, popular bond rating agencies are CRISIL, ICRA, CareEdge, and India Rating and Research. Globally, famous agencies include S&P, Moody's and Fitch.
Bond ratings determine the creditworthiness of a bond issuer. These ratings provide insight into whether the issuer can meet the terms of the bond agreement, including timely repayment of the principal and interest.
| Grade | Rating | Description |
|---|---|---|
| Investment Grade | AAA | Lowest level of credit risk |
| AA+, AA, AA- | Very low credit risk | |
| A+, A, A- | Low credit risk | |
| BBB+, BBB, BBB- | Moderate credit risk | |
| Non-Investment Grade | BB+, BB, BB- | Substantial credit risk |
| B+, B, B- | High credit risk | |
| CCC+, CCC, CCC- | Very high credit risk | |
| CC | Highly speculative | |
| C | Highest level of credit risk | |
| D | Currently in default |
Risks Associated with Bond Investments
I Credit Risk / Default Risk
Credit risk is the risk of losing money because someone doesn't keep their promises. If you invest in a bond with an AAA credit rating, the chances of it defaulting are extremely low. But if you invest in a bond rated C or lower, you're much more likely to lose money if it defaults.
II Interest Rate Risk
Bond prices and interest rates move in opposite directions. When interest rates go up, bond prices tend to fall; when rates drop, bond prices tend to rise. Imagine buying a bond paying a 5% yield: if rates jump to 6%, many investors would sell to buy higher-yielding bonds, pushing the price of the 5% bond down. If rates fall to 3%, demand for the 5% bond rises and its price climbs. Interest rate risk is the fear that your investment value will take a hit when interest rates rise.
III Reinvestment Risk
Reinvestment risk is the chance that the money you make from an investment won't grow as much when you reinvest it. Say you invest in a bond paying 10% interest and earn 50,000 rupees at year-end. If you reinvest but rates have fallen to 8%, you'll only earn 8% on that reinvestment — that's reinvestment risk in action.
IV Liquidity Risk
When there aren't many buyers and sellers in the market, it's called liquidity risk. Bonds are usually less liquid than stocks, especially if holders keep them for the long term. Even listed bonds carry no guarantee of a liquid secondary market. Unlike the huge demand for government bonds, the market for corporate bonds is still small — so investors may not be able to sell when they want to.
V Call Risk
Some bonds have a feature called callability, meaning the issuer can buy back the bond before maturity. The catch: if interest rates are lower than when you bought the bond, you may face reinvestment risk. For example, an 8% bond with a 10-year maturity and 4-year call protection may be called once rates drop below 8% — and even with a bit more principal, the lower rates make reinvesting harder.
Taxation Aspects
Taxes on Interest Income
- Tax payable on receipt of interest income vis-à-vis accrual of interest, as in FDs.
- Tax Slab: Slab rate applicable to the person.
- Individual: Maximum tax rate is 42.74% (from FY 2024-25).
- Corporate: Now ~29%.
TDS
- As per Section 193 of the Income Tax Act, 1961 — 10% TDS for all listed bonds.
- For NRIs, as per Section 195 of the Income Tax Act, 1961 — 20% TDS for all listed bonds.
- For cumulative interest bonds, cumulative TDS will be deducted at maturity.
Capital Gains — Long Term / Short Term
The capital gains imposed on taxable bonds depend on the holding period.
| Listed | ||
|---|---|---|
| Holding Period | ≤ 12 months | > 12 months |
| Type of Capital Gain | Short term | Long term |
| Tax Rate | Income Tax Slab Rate | 12.5% without indexation |
- Tax-free bonds: Issued by PSUs — interest income is exempt from income tax. However, any capital gains on the sale of such bonds would be taxable.
- 54 EC Bonds: Used to save tax on long-term capital gains arising from the sale of a property. Interest is usually paid annually, or compounded and paid at maturity.
- Sovereign Gold Bonds: Investor receives 2.5% interest on the face value, and maturity value equals the price of gold on the maturity date. Interest income is taxable at slab rate with no TDS. Capital gains are taxable only if sold in the market before maturity, but are exempt on maturity.
Retail Market Participants & Investing Strategies
Retail investors can be categorised into three distinct segments:
- Mass Market Investors: Generally possess lower levels of financial education, have limited financial resources, value liquidity, and easy access to cash. Their strategies are typically self-directed or facilitated through employer plans, relying on peer recommendations.
- Affluent Investors: Historically demonstrate a higher level of financial knowledge. They often seek professional guidance to make informed decisions and have access to substantial budgets and a greater capacity for valuing liquidity.
- High-Net-Worth Investors: Generally demonstrate higher financial literacy levels. They frequently seek guidance from financial advisors for portfolio allocation. Their substantial budgets and intricate strategies often lead to a greater propensity to consider illiquid assets.
High-net-worth investors generally demonstrate higher financial literacy levels. They frequently seek guidance from financial advisors for portfolio allocation. Their substantial investment budgets and intricate investment strategies often lead to a greater propensity to consider illiquid assets.
The investing strategy varies across the different types of investors:
| Investor Type | Struggling to find products matching risk preferences | Find products matching risk preferences through a Financial Adviser | Uncomfortable with loss in the short or long term |
|---|---|---|---|
| Mass market | 15% | 30% | 34% |
| Affluent | 9% | 39% | 17% |
| HNI | 2% | 47% | 10% |
Tailwinds & Headwinds for Retail Participation
Tailwinds
- Reduction in face value: Lowering face value from 10 lakhs to 10,000 for private placements.
- Debt IPO limit adjustment: Reducing the limit for Debt IPOs to INR 10 crores (face value INR 1,000).
- Retail access via cash segment of Exchange & RFQ platform: Empowering retail investors to trade bonds through the cash segment of Exchanges as well as RFQ platforms.
- Guidelines for Online Bond Platform Providers (OBPP): Regulatory framework and working group set up by SEBI to enhance retail participation.
Headwinds
- Demat & KYC burden: Bonds are credited to the investor's demat account (governed by SEBI under the Depositories Act, 1996). Full KYC could be minimised to a simple declaration to ease onboarding — also aiding NRI participation.
- Tax compliance: For lower or nil tax deductions, an automated validation process built by the issuer directly with the Income Tax portal would reduce the compliance burden, particularly for senior citizens.
- Education & awareness: A comprehensive, regular awareness program on the benefits and risks of bond investments — particularly those issued by NBFCs.
Role of Chartered Accountants
While the equity market receives substantial attention in public discourse, the corporate bond market in India has experienced steady growth and holds substantial potential for raising long-term capital. Despite this growth, India's corporate bond market remains relatively underdeveloped compared to global standards — primarily due to low liquidity in corporate bonds, complex regulations, credit risk, and limited awareness among retail investors. As Chartered Accountants, we can help bridge these gaps by educating both businesses and investors about the advantages and risks associated with the corporate bond market, as well as its significance in the overall growth of the economy and investment portfolios.
Conclusion
The bond market presents a stable investment avenue, with government bonds offering the utmost security. Growing institutional and retail participation is bolstering market liquidity and resilience. Furthermore, bonds serve as a diversification tool, extending beyond the traditional stock portfolio. The increasing institutional demand for bonds is positively impacting liquidity. Technological advancements have democratised bond investments, enhancing their accessibility and transparency. If the analysis holds true, this will empower investors to achieve consistent returns.