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What is a Straight Bond?

Every business, regardless of the scale at which they operate, relies heavily on raising capital through debt. However, lending money from traditional financial institutions like banks can come at high interest rates that might not be justifiable in the long run. This is where options like straight bonds come into the picture. 

Straight bonds are also known as vanilla bonds as these simply offer returns through interest rates to the investor, and at maturity, even the principal amount that was originally invested is returned.

Imagine that you have lent money to your friend who has promised to pay back the amount on a specific date and till that date comes, they also pay you interest amount. This is exactly how straight bonds operate. Since these types of bonds are often predictable and help generate a steady stream of income, even novice investors put their money in straight bonds.

But is that all that you need to know about straight bonds? No. Let’s break down the details of straight bonds, like their specific characteristics, things to consider before investing in bonds, etc.

Characteristics of Straight Bonds

Amongst others, straight bonds can be characterised by features such as fixed interest payment, defined maturity rate and return of the principal amount at maturity. Let’s break down these characteristics of straight bonds in detail for a better understanding: 

  • Fixed Interest Payments

Investing in straight bonds typically comes with the option of generating income through fixed interest rates. These interest rates are predetermined, and therefore, straight bonds are generally considered a stable and predictable investment option. The interest payment is done at regular intervals until the date of maturity comes. Depending on the type of straight bond, the interest payment dates are decided.

  • Defined Maturity Date

Another key characteristic of straight bonds is that these kinds of bonds have a fixed maturity date upon which the bond issuer is under an obligation to repay the principal amount to the investor.

  • Return of Principal at Maturity

The bond issuer under straight bonds is under an obligation to pay the principal amount invested at maturity. This principal amount is the amount that the investor has invested initially at the starting of investing in the bond. Know that the principal amount in the context of straight bonds is also known as the face value.

Advantages of Investing in Straight Bonds

Even though straight bonds are considered a rather basic type of financial instrument these types of bonds come with several advantages. Let’s take a look at some of the advantages of investing in straight bonds:

  • Steady Income Stream

Investing in straight bonds comes with a key advantage, which is a generation of a steady income. For Investors who focus on stable returns and a regular income stream, straight bonds prove extremely advantageous. 

  • Less Prone to Risks

Another advantage of investing in straight bonds is that they are less prone to risk as compared to stocks or other kinds of bonds. Since they come with fixed income payments through interest rates and repayment of principal amounts on maturity, investors view straight bonds as an ideal option to navigate through other risky investments.

  • Preserved Capital

Unlike other investments where there is an uncertainty of return of the principal amount invested, straight bonds come with the option for the repayment of the principal amount or the face value at maturity.

Additional Info: These kinds of bonds have even more stability if they are issued by the government or highly rated corporate institutions.

  • Benefits Through Interest Rates

In addition to the fact that straight bonds offer predetermined interest rates to investors, investors can also benefit from the changes in the interest rate. A simple rule of straight bonds is that when the interest rate decreases, the chances of the existing bond’s value to rise also increase. This is primarily because when new bonds are issued at a slightly lower rate, the existing bonds become more attractive, thus offering an opportunity to expand the profit margin.

Risks Associated with Straight Bonds

Straight bonds are known for their stability and return of face value. However just like any other investment, straight bonds are not risk-free. If you are planning to invest in these kinds of bonds, here’s a list of risks that you must be considerate of:

  • Risk with Interest Rates

As discussed above, investors can benefit when the interest rate decreases as it leads to a rise in the value of the existing straight bonds. However, when the interest rate rises, the value of the existing straight bonds decreases. In such a situation, if an investor decides to sell their bonds before maturity, there are high chances of them facing a loss.

  • Risk with Liquidity Options

Another risk that you should be mindful of before investing in straight bonds is that they often lack liquidity because of the low trading volume of small corporations. Additionally, finding a buyer of straight bonds can be difficult and might lead to offering bonds at discounted rates.

  • Risk with Credit Amount 

Although straight bonds are known for stable returns and repayment of the principal amount, there might be chances of credit risk. For instance if the bond issuer is the government that is facing financial challenges, investors might have to deal with a credit risk. Or if the bond issuer is a low-rated corporation or a small corporation there is always credit risk associated with the investment.

  • Risk with Inflation

Remember that in the context of straight bonds, rising inflation increases the risk. This is because the fixed interest payment or return of face value tends to lose this purchasing power over time if the inflation is high.

How Does Straight Bonds Work?

Let’s understand how straight bonds function:

  • Raising capital is a fundamental need for the government and corporate institutions. To raise capital, governments and corporations issue bonds, which are loan instruments.

  • Straight bonds are simple forms of bonds issued by the government or corporation. These come with simple attributes that include payment of a predetermined fixed rate at regular intervals and repayment of the principal amount or the face value at maturity.

  • Since bonds are issued with a slightly lower interest rate as compared to traditional financial institutions, the bond issuer would benefit by minimising their total cost of capital and investors can benefit from a steady and slightly predictable return.

  • Additionally, investors also have the option to sell or redeem the bond before maturity to expand a profit margin by leveraging market opportunities.

Let’s take a simple example to understand the working of straight bonds better:

Say that a certain company issues a straight bond with a face value of ₹1,900 and at an interest or coupon rate of 6% per year with a maturity of five years.

Now, if you purchase the bond at its face value, i.e. ₹1,000, then you will be earning ₹60 per year for the next five years and at the end of maturity, you will get back your principal amount. This way, you would have made a profit of ₹300 while also getting back the principal invested amount, i.e. ₹1,000.

Simultaneously, the bond issuer would have raised enough capital through various investors for its everyday business activities and expansion strategies without having to pay unreasonable interest rates.

Things to Consider

If you are planning to invest in straight bonds, here’s a list of things to consider before deciding:

  • Evaluate the Attributes Carefully

One of the key advantages of investing in straight bonds is that it creates a consistent stream of income for the investors. Therefore, you must carefully evaluate the interest of the coupon rate, the conditions of repayment at maturity and the intervals at which interest rates are payable to make profits through the unique features of straight bonds.

  • Understand the Liquidity

Remember that when it comes to straight bonds the liquidity is slightly limited as compared to other bonds or stocks in the market. There are high chances that you might end up selling your straight bonds at discounted rates before maturity due to lower trading volume and the decrease in the bond value.

Pro Tip: Investors of straight bonds generally stay away from selling their bonds before maturity, and they hold their bonds to generate profit through interest-rate and redemption of the face value at maturity.

  • Leverage Market Opportunities Smartly

If you plan to sell your straight bonds before maturity, make sure to find windows where the interest rate has declined, as this often leads to an increase in the value of your straight bonds. 

Conclusion

Investing in straight bonds is a reliable option for investors who prioritise stable and predictable returns. While offering the key features of a bond instrument, straight bonds offer other benefits like reduced risk and do not require you to analyse the market trends constantly. However remember to evaluate the certain risk like liquidity and value changes during inflation.

To start your trading journey, remember that you need to have a valid demat and trading account. Make sure to choose a reliable broking platform that promises you unique features like technical and fundamental analysis of the market etc, to make your trading journey seamless and quick.

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Disclaimer: Investments in the securities market are subject to market risk, read all related documents carefully before investing.

This content is for educational purposes only. Securities quoted are exemplary and not recommendatory.

For All Disclaimers Click Here: https://www.bajajbroking.in/disclaimer

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