Zero Coupon Bonds
As the name suggests, these bonds do not pay interest during the life of the bonds. The bond is issued at a discount to its face value, and matures at its face value.
The difference between the issue price and redemption price represents the return to the bondholder. The buyer of these bonds receives only one payment, which is at the maturity of the bond.
For example – if a bond with face value of Rs 1,000 is issued at a discounted rate of Rs 900 for a period of two years, the investor will get Rs 1,000 at the end of two years. The additional Rs 100 is your (in-built) return (interest income).
Coupon Rate of a Bond is Not Your Actual Return
If a bond offers a coupon of say 12.75%, you may end up with negative return if you buy this bond. This is because interest earned on bonds is added to your total income & taxed at marginal rate of income tax depending on the tax-slab you belong to. So effectively, your gain will be far less than the coupon rate of the bond. For someone in the 30% income tax slab, the actual rate of return for a 12.75% coupon rate will be 8.9%.
Record Date and Ex-Date is an important factor that investors should keep in mind while trading/investing in corporate bonds.
Record date is the date on which all the bond holders will be eligible for the interest payment for that period. The issuer of the bond sets record date for interest payment. Ex-date is set based on this record date. The trades which take place after the ex-date are not eligible for interest payment for that period. The Ex-date is usually two business days before the record date.
Also Read – Ex date vs Record date
Listing of Bonds on Exchange
Securities and Exchange Board of India (SEBI) in its regulation – Issue and Listing of Debt Securities Regulations, 2008 has made it mandatory for every listed company (issuer) to list its debentures and bonds on one or more recognized stock exchanges.
Why Does the Price of a Fixed Coupon Rate Bond Move Unevenly?
This is a very valid question. Let’s assume a bond with the face value of Rs. 1,000 with a 12% coupon rate. Interest to be paid on the 1st of April every year and the record date set on the 15th of March.
Shouldn’t the price of the listed bond appreciate by 12% gradually through the year, peaking to Rs. 1,120 on the 15th of March and falling back to Rs. 1,000 on the 16th of March?
It totally should. Unfortunately, the moment you get something listed on the exchange, its price will move based on demand and supply and not so much on coupon (interest) rate. Further, the underlying security and whether the bond is secured or unsecured also has a bearing on the price of the bond. For this reason, in times of economic uncertainty, unsecured bonds in particular routinely fall below their face value.