Bonds & Debentures — Yields, Ratings and Real Risks
How a bond actually pays you, what yield to maturity really means, how to read a credit rating, and where retail investors get hurt — government bonds, PSU bonds, NCDs and debt funds.
A bond is a loan you give instead of take. You hand over money for a fixed term, collect interest at a fixed rate, and get your principal back at maturity. That simplicity is why bonds are the backbone of every conservative portfolio — and why they are so easily mis-sold. The two numbers that decide whether a bond is a good deal are its yield and its credit rating, and most retail investors read both wrongly. This guide fixes that.
How a bond actually works
Every bond has four defining features: the face value (usually ₹1,000 or ₹100 in India), the coupon (annual interest as a % of face value), the tenure, and the issuer. A 7% ₹1,000 bond maturing in 2031 pays you ₹70 a year — normally in two half-yearly instalments of ₹35 — and returns ₹1,000 on the maturity date. Nothing more, nothing less.
"Debenture" is simply the word Indian company law uses for a corporate bond. A Non-Convertible Debenture (NCD) stays a loan until maturity; a convertible debenture can turn into shares. Debentures may be secured (backed by specific assets) or unsecured — check the offer document, because that single line decides what you recover if the company fails.
The one idea to hold on to
A bondholder is a lender, not an owner. You do not share in profits, so the best case is only that you get paid on time. That's why the entire job of bond analysis is judging the chance of not being paid.
Coupon, current yield and yield to maturity
Bonds trade after issue, and their price moves. Once the price is no longer ₹1,000, the coupon stops describing your return. Three different numbers get quoted, and platforms often show the flattering one.
| Measure | What it means | Example (7% bond bought at ₹950, 5 yrs left) |
|---|---|---|
| Coupon rate | Interest as % of face value — fixed forever | 7.0% |
| Current yield | Annual interest ÷ price paid | ₹70 ÷ ₹950 = 7.4% |
| Yield to maturity (YTM) | Total return if held to maturity, including the ₹50 capital gain, compounded | ~8.2% |
YTM is the only figure comparable across bonds. Ask for YTM net of all platform charges before you buy.
Price and yield move in opposite directions. If market rates rise to 8%, nobody will pay ₹1,000 for a 7% bond — its price falls until its yield matches 8%. That is interest-rate risk, and it grows with tenure: a 1% rate rise moves a 3-year bond's price by roughly 3%, but a 20-year bond by 12–15%.
Beware the "12% return" bond ad
A yield far above the G-Sec rate for the same tenure is not a bargain — it is the market pricing in default risk. In 2026, if 5-year G-Secs yield ~6.8% and something offers 12.5%, you are being paid roughly 5.7% a year to accept a real chance of losing your capital.
Reading credit ratings without fooling yourself
CRISIL, ICRA, CARE, India Ratings and Brickwork grade issuers from AAA down to D. The scale is not linear — the gap in default probability between AA and BBB is far larger than the two notches suggest.
| Rating | Meaning | Typical issuer | Retail verdict |
|---|---|---|---|
| AAA | Highest safety | SBI, HDFC Bank, NHAI, PFC | Core holding |
| AA / AA- | High safety | Large NBFCs, top private issuers | Fine in moderation |
| A | Adequate safety | Mid-sized NBFCs | Small amounts, short tenure only |
| BBB | Moderate — lowest investment grade | Small finance, MFI-linked NCDs | Speculative for retail |
| BB and below | High risk | Stressed issuers | Avoid |
| D | Default — payment already missed | — | Avoid |
- •A rating is an opinion on one date, not a guarantee — IL&FS was AAA weeks before it defaulted in 2018, and DHFL was AAA in 2018.
- •Watch the outlook and the direction: a downgrade from AA to A+ tells you more than the letter itself.
- •'Provisional' or 'Issuer Not Cooperating (INC)' tags are red flags; INC means the rating agency has stopped getting information.
- •Ratings apply to a specific instrument. A company's NCD can be rated lower than its bank loans if it ranks behind them in a wind-up.
The 30-second check
Before buying any corporate bond: rating and its trend over 2 years, whether it's secured, the issuer's interest coverage ratio, and how much of your total portfolio this single issuer would be. If any answer is uncomfortable, buy a G-Sec instead.
The Indian bond menu
| Instrument | Issuer | Indicative yield (2026) | Key point |
|---|---|---|---|
| Treasury Bills | Govt of India, 91–364 days | ~6.3–6.6% | Zero credit risk; parking money |
| G-Secs | Govt of India, 5–40 yrs | ~6.7–7.2% | Sovereign; price swings with rates |
| State Development Loans | State governments | ~7.0–7.4% | Sovereign-like, slightly higher yield |
| PSU / AAA bonds | PFC, REC, NHAI, IRFC | ~7.2–7.7% | The retail sweet spot |
| Tax-free bonds | Older NHAI/IRFC/PFC issues | ~5.0–5.7% tax-free | Secondary market only; great at 30% slab |
| Corporate NCDs | NBFCs and companies | 8–11% | Read rating and security cover |
| Perpetual (AT1) bonds | Banks | 8–9% | No maturity date; can be written off |
| Sovereign Gold Bonds | Govt of India | 2.5% + gold price | Gold exposure, not a fixed-income bond |
Perpetual bonds are not fixed deposits
AT1 bonds have no maturity date and can be written down to zero if the bank is in trouble — Yes Bank's ₹8,400 crore AT1 write-off in 2020 wiped out thousands of retail holders who were told it was 'like an FD with a better rate'. SEBI has since restricted them largely to institutions.
Tax-free bonds deserve a second look if you are in the 30% slab. A 5.5% tax-free coupon equals about 7.9% pre-tax — better than most AAA taxable bonds, with sovereign-linked issuers. They are no longer issued, so you buy them on NSE/BSE where volumes are thin: use limit orders.
How to buy bonds in India
- 1RBI Retail Direct (rbiretaildirect.org.in) — buy G-Secs, T-Bills, SDLs and SGBs directly, no brokerage, no demat needed. The cheapest sovereign access in the country.
- 2Your broker's bond section or a SEBI-registered Online Bond Platform Provider (OBPP) — corporate bonds and PSU bonds from ₹1,000 up; only use SEBI-registered OBPPs.
- 3Public NCD issues — subscribe during the offer window through your demat account; read the credit rating and 'objects of the issue' pages.
- 4Debt mutual funds and target-maturity index funds — a professionally managed basket instead of single-issuer risk; the practical default for most people.
For a portfolio under about ₹10 lakh in debt, a target-maturity index fund or a short-duration debt fund usually beats hand-picking bonds: you get 30–60 issuers, daily liquidity and no coupon-reinvestment hassle. Buy individual bonds when you want a specific maturity date to match a goal, or when a tax-free bond's post-tax yield is genuinely superior.
Match tenure to the goal
Money needed in 2 years belongs in a 2-year bond or T-Bill, not a 15-year G-Sec. Holding a bond to maturity makes interest-rate risk irrelevant — you get your face value back regardless of what happened to prices in between.
The five risks that actually cost money
- •Credit risk — the issuer misses interest or principal. The only complete cure is sovereign issuers; the practical cure is diversification and staying at AA and above.
- •Interest-rate risk — rates rise, prices fall. Irrelevant if you hold to maturity; painful if you must sell early or hold long-duration funds.
- •Liquidity risk — small corporate bonds can be almost unsellable mid-way, or sellable only at a 2–4% discount. Check traded volumes before you buy.
- •Reinvestment risk — your 8% bond matures and the market now offers 6%. A ladder of 1/3/5/7-year maturities smooths this out.
- •Call risk — some bonds can be redeemed early by the issuer, always when rates have fallen and you'd rather keep the high coupon.
Concentration turns a manageable risk into a disaster. A 5% position in a defaulted NCD costs you a bad year; a 40% position costs you a decade. No single non-sovereign issuer should exceed 5% of your total portfolio.
How bonds are taxed (FY 2026-27)
| Income | Treatment |
|---|---|
| Interest / coupon | Added to income, taxed at your slab rate |
| Tax-free bond interest | Fully exempt under Sec 10(15) |
| Listed bond sold after 12 months | 12.5% LTCG, no indexation |
| Listed bond sold within 12 months | Slab rate |
| Unlisted / market-linked debentures | Always taxed as short-term at slab rate (Sec 50AA) |
| Debt mutual funds (bought after Apr 2023) | Gains taxed at slab rate on redemption |
| SGB held to maturity | Capital gain exempt; the 2.5% interest is taxable |
Two practical consequences. First, at the 30% slab a 9% taxable NCD nets about 6.2% — often less than a 5.5% tax-free bond. Compare post-tax yields, never headline coupons. Second, since debt funds lost indexation, holding individual bonds to maturity or using an arbitrage/equity-savings fund for 3-year money can be more tax-efficient; run the numbers for your own slab.
TDS
TDS at 10% applies on interest above ₹10,000 a year from listed bonds held in demat. It's a credit against your final tax, not an extra cost — but you still declare the full interest in your return.
Common mistakes to avoid
Chasing the highest yield on a bond platform
Yield above the sovereign curve is compensation for default risk, not free money. Sort by rating first, then look at yield.
Treating an NCD like a fixed deposit
There is no ₹5 lakh DICGC cover on a corporate bond. If the issuer fails, you join the insolvency queue.
Buying long-duration bonds for short-term money
A 20-year G-Sec can fall 12% in price if rates rise 1%. Match the maturity to when you need the money.
Ignoring 'unsecured' and 'subordinated' in the term sheet
These words decide your position in a default. Subordinated and perpetual instruments get paid last, or not at all.
Putting a large share in one issuer's NCD
DHFL and IL&FS holders learned this the hard way. Cap any single non-sovereign issuer at 5% of the portfolio.
Your action checklist
- Decide the debt allocation first (a common rule: your age as the % in debt), then how to fill it.
- Use RBI Retail Direct for G-Secs, T-Bills and SDLs — no brokerage, no middleman.
- For corporate bonds, stay at AA and above and check the rating trend over the last two years.
- Compare YTM net of charges, never the coupon; compute post-tax yield for your slab.
- Cap each non-sovereign issuer at 5% of the total portfolio.
- Match maturity to the goal date so you can hold to maturity and ignore price swings.
- Check traded volumes before buying anything on the secondary market; use limit orders.
- Skip perpetual (AT1) and market-linked debentures unless you fully understand the write-off clause.