A debt instrument is generally issued for a longer tenure i.e. for more than one year. These instruments are issued with the purpose of raising tier-II capital by borrowing. The Federal governments, states governments, municipal corporations, corporate, financial institutions and many other types of institutions sell bonds. Generally, these bonds carry a fixed rate of interest usually known as coupon and are issued for a fixed tenure with defined date of maturity. A bond is a promise to repay the principal along with interest (coupons) on a specified date (maturity). There are zero coupon bonds available which promise to pay a fixed sum on maturity.

The investor of these bonds steps into the shoes of a creditor of the issuer. However, the buyer does not gain any kind of ownership rights to the issuer, unlike in the case of equities. On the other hand, a bond holder has a greater claim on an issuer's income than a shareholder in the case of financial distress like any other creditor.

Various types of bonds are issued. They can be categorized as under:

  1. Tax Free Bonds or Taxable Bonds.
  2. Zero Coupon or Fixed Coupon Bonds.
  3. Secured or Unsecured Bonds.
  4. Rated or Unrated Bonds.


U.S. Treasury bonds are generally considered the safest unsecured bonds, since the possibility of the Treasury defaulting on payments is almost zero.

The yield from a bond is made up of three components: coupon interest, capital gains and interest on interest (in case of a cumulative bond). In case of Deep discounted bonds the only yield will be capital gains.

Market price of these bonds is determined with yield to maturity (YTM). The YTM of a bond depends upon the prevailing interest rates and the credit quality of the instrument. A bond with low credit rating has to provide a higher payout to compensate for that additional risk.