 "Secondary bond market: What retail investors must know about rates, yields")
Investing in bonds in the secondary market is a rising trend. Retail investors can use demat accounts to buy such bonds with face values ranging from Rs 1,000 to Rs 10,000. Understanding the secondary bond market is important before investing in it.
Understanding the secondary bond market
The secondary market allows investors to buy and sell previously issued bonds, offering liquidity and flexibility for bondholders wanting to sell before maturity. Unlike the primary market, transactions here occur between investors, with proceeds going directly to the seller, not the issuer.
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Types of bonds in Indian secondary market
PSU bonds: Issued by public sector companies, where the government holds more than 51 per cent of the shareholding.
Corporate bonds: These are issued by corporations to raise funds from the market, offering higher yields than government securities.
Tax-free bonds: The interest earned from these bonds is typically exempt from taxes, making them attractive to investors.
Government securities: To finance public projects, the government raises funds by issuing securities to the public.
Sovereign gold bonds: Issued by the central government, these bonds provide a secure way to invest in digital gold.
Green bonds: These bonds are specifically designed to raise funds for environmental and climate-related projects.
Covered bonds: Typically issued by local governments or their agencies to finance public infrastructure projects such as parks and roads.
“The current market scenario presents an interesting opportunity. With the 10-year government bond yield hovering around 6.835 per cent (as of January 2025), and corporate bonds offering spreads of 50-150 -250 basis points above this, investors can secure attractive returns. However, understanding the inverse relationship between interest rates and bond prices is crucial. This relationship means that as interest rates decline, bond prices typically appreciate, potentially offering capital gains in addition to regular interest income,” said Tanvi Kanchan, head of strategy, Anand Rathi shares and stock brokers.
Experts suggest these points while buying bonds from secondary markets
Maturity and interest rate risk: The maturity of a bond influences its price sensitivity to interest rate changes. In a market expecting rate cuts, longer-duration bonds might offer better capital appreciation potential but come with higher volatility.
Credit quality considerations: The Indian bond market has seen several high-profile defaults in recent years, underscoring the importance of credit quality assessment.
Liquidity assessment: Market liquidity varies significantly across different bonds. Government securities and top-rated PSU bonds generally enjoy good liquidity, with bid-ask spreads of 1-2 basis points. Corporate bonds, especially lower-rated ones, might have spreads of 5-10 basis points or more, impacting trading costs and exit flexibility.
Call options and reinvestment risk: In a market expecting rates to decline, callable bonds require special attention. For example, a bond offering an 8.5 per cent coupon with a call option after three years might be called if rates drop significantly, forcing investors to reinvest at lower prevailing rates.