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26 Dec 2020

What will guarantee my principal repayment?

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When you invest in a bond, you have a cash outflow and over the years, you get regular coupon inflows and at the time of maturity, you get your principal back. Basically its like a loan that you take for your mortgage, where you receive the value of the property cost from the bank and then you keep paying EMIs until the maturity period of the loan

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Arjun Parthasarathy

Three Questions to ask to avoid bond mishaps

In the previous 2 issues of Search for Yields newsletter, the free weekly newsletter from INRBonds to help bond advisors and investors alike in investments in bonds and other fixed income investments, we introduced 3 questions to ask to avoid bond mishaps and we covered the 1st question. The questions were :

 

Will interest rates move up or down in the future?

What will guarantee my principal repayment?

Can I sell the bond if I see a threat to my investment?

We will now answer the 2nd question, what will guarantee my principal repayment?

 

Bonds have coupon and principal that come to you when you invest in the bond

When you invest in a bond, you have a cash outflow and over the years, you get regular coupon inflows and at the time of maturity you get your principal back. Basically its like a loan that you take for your mortgage, where you receive the value of the property cost from the bank and then you keep paying EMIs until the maturity period of the loan.

The mortgage EMIs you pay come from the salary you earn or your business income or from renting the property. In case any of the cash flows stop, you would have to dip into your savings or even sell your property to avoid defaulting on the loan taken from the bank.

Similar is the case with a bond where the issuer borrowers from you at a certain interest rate and repays the loan to you over a period of time.

 

 

 

How does an Issuer service the interest on the bond and repay the principal?

The bond issuer depends on regular cash flows from business activities to service the interest on the bond. The issuer also creates a pool of savings to repay the principal when the bond comes up for maturity. If there is a slowdown or disruption in the business, the issuer will have to dip into reserves or even sell the business if possible to avoid default.

However, many issuers do not have regular cash flows immediately to service the bond and in such cases they will have structured the bond in ways that will enable them to service the bond over a period of time. Such bonds where issuers do not have regular cash flows or even make continuous business losses will have guarantees or other inbuilt mechansims to provide comfort to bond investors on the issuer's ability to service the bond.

 

What will guarantee my principal repayment?

The primary guarantee of your principal repayment is the soundness of the business of the issuer. If the issuer is able to reply funds where the return on the investment in the business is higher than the interest payable on the bond, you will be assured of principal repayment.

The other guarantees of your principal repayment include, guarantee by the promoter of the bond issuer. For example in the case of government, the central government can print money to repay bond holders, state governments can get funds from the central government or RBI to repay bond holders.

Many issuers are also able to raise fresh money through issue of bonds to repay bond holders and this ability to raise fresh capital can guarantee your principal repayment.

Before making a bond investment, always check what will guarantee your principal repayment.

Disclaimer:

Information herein is believed to be reliable but Arjun Parthasarathy Editor: INRBONDS.com does not warrant its completeness or accuracy. Opinions and estimates are subject to change without notice. This information is not intended as an offer or solicitation for the purchase or sale of any financial instrument. The financial markets are inherently risky and it is assumed that those who trade these markets are fully aware of the risk of real loss involved. Unauthorized copying, distribution or sale of this publication is strictly prohibited. The author(s) of the content published in the site INRBONDS.com may or may not have investments in the assets discussed in the pages/posts.

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