Bonds are loans issued by entities like governments and corporations to investors. There are several types of bonds:
Regular bonds have a fixed coupon and maturity date with no call or put options. Callable bonds allow the issuer to redeem the bond before maturity if interest rates decline. Puttable bonds give the investor the right to sell the bond back to the issuer before maturity if rates rise. Convertible bonds can be converted into equity in the borrowing firm. Perpetual bonds have no maturity date but may have a call option, while tier-2 bonds under Basel III standards have fixed coupons and maturity but a call option.
2. What are BONDS ?
• A bond is simply a loan with a definitive
instrument features taken (issued) by an entity
from the lender. Here, the entities taking a loan
could be governments (central, state or municipal
bodies) or companies (PSUs, private corporates,
financial institutions etc) and are called as Issuers.
The lender could be individuals, corporates,
mutual funds, banks or anybody who invests in
order to receive periodic income and are called as
Investors.
3. A. REGULAR BONDS (PLAIN VANILLA
BONDS)
• Fixed Coupon
• Maturity Date is fixed
• Does not have a call / put option
• Issued at Par
4. B. CALLABLE BONDS
• Bonds that allow the issuer to exercise a call
option and redeem the bonds prior to its
original maturity date.
• Since these options are not separated from
the original bond issue, they are also called
embedded options.
• The call option provides the issuer the option
to redeem a bond, if interest rates decline,
and re-issue the bonds at a lower rate.
5. C. PUTTABLE BONDS
• Provide the investor with the right to seek
redemption from the issuer, prior to the
maturity date.
• A put option provides the investor the right to
sell a low coupon-paying bond to the issuer,
and invest in higher coupon paying bonds, if
interest rates move up.
6. D. CONVERTIBLE BONDS
• A convertible bond provides the investor the
option to convert the value of the outstanding
bond into equity of the borrowing firm, on pre-
specified terms
• Exercising this option leads to redemption of the
bond prior to maturity, and its replacement with
equity
• Bonds can be fully converted or partly converted
depending up on the predetermined terms
7. E. PERPETUAL BONDS
• Fixed Coupon
• No Maturity Date
• Generally has a call option at the end of 5th or
10th year.
• Generally have a step up in coupon if call
option is not exercised, i.e., the initial coupon
rate will rise by pre-specified basis points
mentioned at the time of issuance.
8. E. PERPETUAL BONDS
• Perpetual structure but should conform to the
basel III norms set by the committee of global
apex banks
• Standards set to improve robustness in banks
and to increase capitalisation levels
• Have certain covenants such as clause on
conversion to equity, loss of principal or
interest or both etc in the event of reaching a
pre-described trigger levels.
9. G. BASEL III - TIER-II BONDS
• Fixed Coupon
• Maturity Date is fixed
• Has a call option at the end of 5-10 years