Bond Market in India: Types of Bonds, Yield, Duration and Risks for RBI Grade B Finance
Last updated: 2026-11-13 · MockMentor
The bond market is part of the Financial Markets line of the RBI Grade B Finance syllabus, and it is a topic where both concepts and numericals are asked. Objective questions test the inverse relation between price and yield, the meaning of yield to maturity and duration, and the features of instruments such as STRIPS, green bonds and AT1 bonds. Descriptive questions have asked about AT1 bonds, the corporate bond market and India's inclusion in global bond indices. This chapter covers the structure of the Indian bond market, types of bonds, the mathematics of yield, the risks and recent reforms.
In one line: a bond is a loan to an issuer that pays fixed interest and returns the principal at maturity; its price moves opposite to interest rates, and India's bond market is led by government securities while the corporate bond market remains shallow.
Basic concepts
- Bond: a debt instrument in which the issuer borrows money from investors and promises to pay periodic interest and repay the principal on a fixed date.
- Face value (par value): the amount the issuer repays at maturity, on which coupon is calculated.
- Coupon rate: the annual interest rate paid on the face value. A ₹1,000 bond with a 7% coupon pays ₹70 a year.
- Maturity: the date on which the principal is repaid.
- Yield: the return an investor actually earns, which depends on the price paid. When the price falls, the yield rises.
- Debenture: in India, a debt instrument issued by a company. Strictly, a debenture is unsecured and a bond secured, but the terms are often used interchangeably.
- Credit spread: the extra yield on a corporate bond over a government bond of the same maturity, reflecting credit risk.
Why in News?
- The Union Budget 2026-27 set gross market borrowing of the central government at a record ₹17.2 lakh crore, which affects bond supply and yields.
- Indian government bonds were included in the JP Morgan Government Bond Index-Emerging Markets from June 2024, the Bloomberg Emerging Market Local Currency index from January 2025 and the FTSE Emerging Markets Government Bond Index from September 2025, using the Fully Accessible Route (FAR).
- RBI's rate hike of October 2026 to 5.50% and the rise in inflation pushed up bond yields across maturities.
- SEBI reduced the minimum face value of privately placed corporate bonds to ₹10,000 in 2024, making them more accessible to retail investors through online bond platforms.
Structure of the Indian bond market
| Segment | Issuer | Features |
|---|---|---|
| Government securities (G-secs) | Central government | Dated securities of 2 to 50 years; the largest and most liquid segment |
| State Development Loans (SDLs) | State governments | Dated securities; trade at a spread over central G-secs |
| Treasury bills | Central government | Up to 364 days; part of the money market |
| Corporate bonds | Companies, banks, NBFCs, PSUs | Mostly privately placed; dominated by highly rated financial firms and PSUs |
| Municipal bonds | Urban local bodies | Small but growing, with an incentive from the central government for issues above ₹1,000 crore |
How G-secs are issued
RBI, as the government's debt manager, issues dated securities and T-bills through auctions on its E-Kuber platform, following a half-yearly borrowing calendar. Auctions can be:
- Yield-based (uniform or multiple price): bidders quote yields, which sets the coupon for a new security.
- Price-based: bidders quote prices for an existing security.
Non-competitive bidding lets small investors, including individuals, buy at the average auction price. Primary Dealers underwrite the auctions. Secondary trading takes place mainly on the Negotiated Dealing System-Order Matching (NDS-OM) platform, and CCIL settles trades.
Types of bonds
By coupon
| Type | Feature |
|---|---|
| Fixed rate bond | Coupon fixed for the life of the bond |
| Floating Rate Bond (FRB) | Coupon reset periodically against a benchmark, such as the T-bill yield |
| Zero coupon bond | No coupon; issued at a discount and redeemed at face value |
| Inflation-indexed bond | Principal or coupon adjusted for inflation, protecting real returns |
| Step-up or step-down bond | Coupon rises or falls on set dates |
By special features
| Type | Feature |
|---|---|
| Callable bond | The issuer can repay before maturity, usually when rates fall |
| Puttable bond | The investor can demand early repayment |
| Convertible bond | Can be converted into equity shares of the issuer |
| Perpetual bond | No maturity date; pays coupon indefinitely unless called |
| Separate Trading of Registered Interest and Principal of Securities (STRIPS) | Each coupon and the principal of a G-sec are separated and traded as zero coupon securities |
| Covered bond | Backed by a pool of assets that stays on the issuer's books |
By purpose or issuer
| Type | Feature |
|---|---|
| Green bonds | Proceeds used only for environmental projects; India issued its first Sovereign Green Bonds in January 2023 |
| Masala bonds | Rupee-denominated bonds issued abroad, so the foreign investor bears currency risk; IFC issued the first in 2014 |
| Social and sustainability-linked bonds | Funds for social projects, or coupon linked to sustainability targets |
| Additional Tier 1 (AT1) bonds | Perpetual bonds issued by banks under Basel III, which can be written down or converted to equity if the bank's capital falls below a trigger |
| Tier 2 bonds | Subordinated bonds of banks with a maturity of at least five years |
| Infrastructure bonds | Long-term bonds of banks for infrastructure and affordable housing loans, exempt from CRR and SLR |
| Sovereign Gold Bonds | Government bonds linked to the price of gold, paying 2.5% interest, issued from 2015; no new tranches have been issued since February 2024, and the scheme was effectively wound down for new issues |
| Tax-free bonds | Interest exempt from income tax, issued by public sector infrastructure firms in the past |
| Retail and savings bonds | Floating Rate Savings Bonds sold by the government to individuals |
AT1 bonds in detail
AT1 bonds count as Additional Tier 1 capital of banks. Their features:
- No maturity; the bank may call them after five years with RBI's approval.
- The bank can skip coupon payments without it being a default.
- Loss absorption: if the bank's Common Equity Tier 1 ratio falls below a pre-specified trigger, or RBI decides that the bank has reached the point of non-viability, the bonds can be written down or converted into equity.
In March 2020, Yes Bank's AT1 bonds worth about ₹8,400 crore were written off under its reconstruction scheme, which led to court cases and showed retail investors that these are high-risk instruments. SEBI then restricted the primary issue of AT1 bonds to institutional investors and set a high minimum ticket size for trading in them.
Bond pricing and yield
Price and yield move in opposite directions
A bond pays fixed coupons. If market interest rates rise, new bonds pay more, so old bonds become less attractive and their price falls until their yield matches the market. If rates fall, the price of old bonds rises.
Example: a bond with a face value of ₹1,000 and a 7% coupon pays ₹70 a year. If market rates rise to 8%, buyers will pay less than ₹1,000 for it; if rates fall to 6%, they will pay more.
| Relationship | Result |
|---|---|
| Coupon rate = market yield | Bond trades at par |
| Coupon rate > market yield | Bond trades at a premium (above face value) |
| Coupon rate < market yield | Bond trades at a discount (below face value) |
Price of a bond
The price of a bond is the present value of its future coupons and principal, discounted at the market yield:
Price = C/(1 + r) + C/(1 + r)^2 + ... + (C + F)/(1 + r)^n
where C is the annual coupon, F the face value, r the yield and n the number of years.
Example: a 3-year bond with a face value of ₹1,000, a 10% coupon and a market yield of 8%.
| Year | Cash flow (₹) | Discount factor at 8% | Present value (₹) |
|---|---|---|---|
| 1 | 100 | 0.9259 | 92.59 |
| 2 | 100 | 0.8573 | 85.73 |
| 3 | 1,100 | 0.7938 | 873.22 |
| Total | 1,051.54 |
The bond sells at a premium of about ₹51.54 because its coupon (10%) is above the market yield (8%).
Measures of yield
| Measure | Formula or meaning | Example |
|---|---|---|
| Coupon yield (nominal yield) | Coupon ÷ face value | ₹70 ÷ ₹1,000 = 7% |
| Current yield | Annual coupon ÷ current market price | ₹70 ÷ ₹950 = 7.37% |
| Yield to Maturity (YTM) | The discount rate that makes the present value of all cash flows equal to the price; the return if held to maturity and coupons are reinvested at the same rate | Found by trial or a financial calculator |
| Approximate YTM | [C + (F − P) ÷ n] ÷ [(F + P) ÷ 2] | For C = 70, F = 1,000, P = 950, n = 5: (70 + 10) ÷ 975 = 8.21% |
| Yield to Call (YTC) | Like YTM, but up to the first call date, using the call price | Used for callable bonds |
| Holding Period Return | (Price received − price paid + coupons) ÷ price paid | The actual return over the period held |
Yield curve
A yield curve plots the yields of bonds of the same credit quality against their maturities.
- Normal (upward sloping): longer bonds yield more, because investors want compensation for time and risk.
- Flat: yields are similar across maturities, often near a turning point.
- Inverted: short-term yields are higher than long-term yields, often seen before recessions.
The theories of the yield curve are the expectations theory, the liquidity preference theory and the market segmentation theory.
Duration and convexity
Macaulay duration is the weighted average time, in years, over which an investor receives the cash flows of a bond, using the present value of each cash flow as the weight. A zero coupon bond's duration equals its maturity; a coupon bond's duration is shorter than its maturity.
Modified duration measures the sensitivity of the bond's price to a change in yield:
Modified duration = Macaulay duration ÷ (1 + yield)
Percentage change in price ≈ − Modified duration × change in yield
Example: a bond with a modified duration of 6 will fall in price by about 6% if yields rise by 1 percentage point.
Convexity captures the curvature of the price-yield relationship. Because of convexity, prices rise more when yields fall than they fall when yields rise by the same amount.
Malkiel's bond theorems
Burton Malkiel set out five relationships that help in reasoning about bond prices:
- Bond prices move inversely to yields.
- For a given change in yield, longer maturity bonds change more in price.
- The price sensitivity rises with maturity but at a decreasing rate.
- A fall in yield raises prices more than an equal rise in yield lowers them.
- Bonds with lower coupons are more sensitive to yield changes than bonds with higher coupons.
Risks in bonds
| Risk | Meaning |
|---|---|
| Interest rate risk | The price falls when rates rise; higher for long-duration bonds |
| Credit or default risk | The issuer may fail to pay; measured by credit ratings |
| Reinvestment risk | Coupons may have to be reinvested at lower rates |
| Inflation risk | Inflation erodes the real value of fixed payments |
| Liquidity risk | It may be hard to sell a bond quickly at a fair price; common in corporate bonds |
| Call risk | The issuer may redeem the bond early when rates fall |
| Currency risk | For bonds in a foreign currency |
| Event risk | Mergers, regulatory changes or write-downs, such as AT1 write-offs |
Credit ratings
Credit rating agencies registered with SEBI rate bonds on a scale from AAA (highest safety) through AA, A, BBB (the lowest investment grade) down to D (default). Many investors, such as insurance companies and pension funds, can invest only in highly rated bonds, which concentrates demand at AAA and AA.
The corporate bond market
India's corporate bond market is much smaller than its government bond market and its bank loan market. Outstanding corporate bonds are about a sixth of GDP, compared with much higher ratios in the United States and Korea.
Why it is shallow
- Most issues are private placements to institutions, with little secondary trading.
- Demand is concentrated in AAA-rated bonds of financial firms and PSUs.
- Insurance and pension funds face investment rules that favour government bonds.
- Weak bankruptcy outcomes in the past discouraged investment in lower-rated bonds.
- Stamp duty and other costs, and a lack of market-making.
Reforms
| Reform | Detail |
|---|---|
| Electronic Book Provider platform | Private placements above a threshold must be through exchange platforms |
| Request for Quote (RFQ) platforms | Exchanges run platforms for secondary trading |
| Corporate bond repo | Allowed to improve liquidity |
| Large corporate borrowers | Listed firms with large borrowings must raise part of new borrowing through bonds (SEBI framework of 2018, revised later) |
| Corporate Debt Market Development Fund (CDMDF, 2023) | A backstop fund that buys corporate bonds from debt mutual funds in times of stress |
| Online Bond Platform Providers | Regulated by SEBI from 2022; retail investors can buy bonds online |
| Lower face value | ₹10,000 for private placements from 2024 |
| Credit enhancement | Partial credit guarantees by banks and NaBFID for infrastructure bonds |
Reforms in the government securities market
- Auction system for G-secs from 1992, replacing administered rates.
- Primary Dealer system from 1995.
- NDS-OM from 2005 for anonymous screen-based trading.
- CCIL as central counterparty from 2002.
- STRIPS (2010), inflation-indexed bonds (2013) and green bonds (2023).
- Fully Accessible Route (FAR) from 2020, allowing foreign investors to buy specified G-secs without limits, which made index inclusion possible.
- RBI Retail Direct (2021), letting individuals hold G-secs directly with RBI.
- When-issued trading and short selling to improve price discovery.
Challenges
- Large government borrowing can crowd out private borrowers and push up yields.
- Banks hold a large share of G-secs, partly because of SLR, which makes their profits sensitive to rate changes.
- Foreign flows after index inclusion can reverse in a crisis.
- The corporate bond market is thin below AA ratings.
- Retail participation is still small.
Way forward
- Continue fiscal consolidation to reduce the supply pressure on yields.
- Widen the investor base for corporate bonds, including through pension and insurance funds and retail platforms.
- Develop credit enhancement and a market for credit derivatives.
- Improve liquidity through market-making and repo in corporate bonds.
- Build municipal and green bond markets for urban and climate finance.
Possible exam and interview questions
- Why is India's corporate bond market less developed than its equity market? Suggest measures to deepen it. (620 words)
- What are AT1 bonds? Why are they considered risky for retail investors? (420 words)
- Explain why bond prices and yields move in opposite directions, with an example.
- Calculate the current yield of a bond with a face value of ₹1,000, a coupon of 8% and a market price of ₹960.
- Interview: What does India's inclusion in global bond indices mean for the rupee and for RBI?
Related reading: money market, time value of money, and equity market.
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