Types of Bonds

Bonds can be broadly classified on the basis of the issuer, coupon structure, and maturity profile. The issuer classification is the most frequently tested in the NISM exam and includes government securities, corporate bonds, and hybrid instruments such as convertible bonds.

Within each issuer class, further sub‑categories exist. For example, government securities comprise Treasury bills (short‑term), dated securities, and inflation‑linked bonds, while corporate bonds can be secured, unsecured, convertible, or zero‑coupon.

Why this matters: The risk‑return profile, tax treatment, and regulatory oversight differ markedly across categories. Exam questions often present a bond description and ask you to identify its type or the applicable regulatory framework (e.g., SEBI’s registration requirements for corporate bonds).

• Issuer based classification – primary way the market segments bonds.
• Coupon based classification – determines cash‑flow pattern and valuation method.

Government bonds, commonly called G‑Sec, are issued by the Central or State governments and are considered the safest debt instruments in India because they carry sovereign guarantee.

Key varieties include Treasury bills (maturities up to 364 days), dated securities (2‑30 years), and inflation‑indexed bonds such as RBI Inflation‑Indexed Bonds (IIBs). Coupon payments on dated securities are usually fixed, while Treasury bills are discount instruments with no periodic coupon.

Exam relevance: Questions may ask you to calculate the discount yield on a Treasury bill or to identify the appropriate tax treatment – interest on G‑Sec is taxable as per the Income Tax Act, whereas capital gains on listed G‑Sec may enjoy indexation benefits.

Corporate bonds are issued by Indian companies to raise long‑term capital. They are subject to SEBI registration and must disclose a prospectus detailing the issue size, coupon rate, and security.

Based on security, corporate bonds are classified as secured (backed by specific assets), unsecured or debentures (no specific collateral), and convertible (can be converted into equity at a pre‑specified price). Zero‑coupon bonds are another variant where the bond is issued at a deep discount and redeemed at face value.

From an exam perspective, you need to recognise how credit risk influences the coupon rate and the role of rating agencies such as CRISIL, ICRA, and CARE in assigning credit ratings that affect investor perception.

Hybrid bonds blend features of debt and equity. The most common hybrid instrument is the convertible bond, which pays a regular coupon but gives the holder the right to convert the bond into equity shares of the issuing company at a predetermined conversion price.

Another hybrid is the perpetual bond, which has no fixed maturity date and pays a coupon indefinitely, often used by financial institutions to strengthen Tier‑1 capital under RBI regulations.

Exam tip: Hybrid bonds are tested for their dual nature – you may be asked to compute the effective yield after conversion or to identify the regulatory capital treatment under Basel III norms.

Bond valuation revolves around discounting future cash flows – the periodic coupon payments and the face value repayment – to their present value using an appropriate discount rate, usually the market yield.

Two simple measures frequently appear in the exam: the current yield (annual coupon divided by market price) and the more comprehensive yield to maturity (YTM), which equates the bond price to the present value of all cash flows.

Understanding the distinction is vital because a bond trading at a premium will have a current yield lower than its coupon rate, while YTM will reflect the true return if held to maturity.

Yield to Maturity is the internal rate of return (IRR) that equates the present value of all future cash flows from a bond to its current market price. It assumes that all coupon payments are reinvested at the same YTM rate.

While the NISM syllabus does not require you to solve the YTM equation manually, you must understand its meaning and be able to interpret given YTM values in scenario questions.

Typical exam question: A corporate bond is quoted at a price of Rs. 980 with a face value of Rs. 1,000, a 6% annual coupon, and 5 years to maturity. The YTM is higher than the coupon rate, indicating the bond is trading at a discount.

Interest earned on most bonds is taxed as "Income from Other Sources" at the investor's applicable slab rate. However, capital gains arising from the sale of listed bonds are taxed differently: short‑term capital gains (STCG) for holding periods up to 12 months are taxed at 15%, while long‑term capital gains (LTCG) beyond 12 months attract 10% without indexation.

Zero‑coupon bonds generate a capital gain component rather than interest, so the entire redemption amount is treated as LTCG if held for more than a year.

Exam relevance: Questions may present a bond transaction and ask you to compute the tax liability, distinguishing between interest income and capital gains.