## Bonds as a Source of Long-Term Finance

### What is a Bond?

A bond is a fixed income security used by companies or governments to raise long-term funds. Bonds can be issued through:

Public Issue — offered to the general public
Private Placement — sold directly to select institutional investors

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### Classification Based on Redemption Options

Type	Who Holds the Option	Feature
Callable Bond	Issuer	Issuer can redeem the bond before maturity at a pre-decided call price
Puttable Bond	Investor	Investor can sell the bond back to the company before maturity

> Memory: Callable = Company's right to exit. Puttable = Purchaser's (investor's) right to exit.

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### Types of Foreign Bonds

Bond Type	Key Features
FCCB (Foreign Currency Convertible Bond)	Low interest; payable in foreign currency; convertible to equity at investor's option
Plain Vanilla Bond	Simple bond with fixed interest or issued at discount; no embedded options
Convertible FRN (Floating Rate Note)	Option to convert to long-term fixed security; protects against falling interest rates
Drop Lock Bond	FRN that locks into a fixed rate when interest falls below a trigger level; new fixed rate holds till maturity
Variable Rate Demand Obligation (VRDO)	Investor can sell back to trustee; interest resets periodically; more liquid than regular FRNs
Yield Curve Note (YCN)	Yield varies directly with interest rates; used to hedge interest rate risk
Euro Bond	Issued in a currency different from the country of issue; typically issued by MNCs
Emerging Market Bond	Issued by developing countries; high yield and high risk; risk protected via CDS

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### Types of Indian Bonds

Bond Type	Key Features
Masala Bond	Rupee-denominated bond issued outside India (e.g., NTPC raised funds through this)
Municipal Bond	Issued by municipal corporations to finance urban infrastructure
Government/Treasury Bond	Issued by Government of India, State Governments, or RBI

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### Key Abbreviations

FRN = Floating Rate Notes
CDS = Credit Default Swap
FCCB = Foreign Currency Convertible Bond
VRDO = Variable Rate Demand Obligation
YCN = Yield Curve Note

Worked example

### Example 1

An Indian company issues an FCCB at 4% (vs 10% for a domestic debenture). The investor can convert the bond into equity shares if the share price appreciates. The company benefits from low-cost borrowing; the investor benefits from potential equity upside — showing why FCCB interest rates are lower.

### Example 2

A VRDO investor holds a bond and wants liquidity urgently. Unlike regular FRNs, they can sell it back to the trustee. This 'put' feature makes VRDOs more liquid, illustrating why investors accept a lower yield on them compared to regular FRNs.

### Example 3

NTPC (Indian company) issues Masala Bonds worth ₹2,000 crore denominated in Indian Rupees but listed on the London Stock Exchange. Foreign investors buy these — they bear the currency exchange risk, not NTPC. This is why Masala Bonds are attractive to Indian issuers.

⚠️ Common exam mistakes

Confusing Euro Bond with European bond — a Euro Bond is defined by currency mismatch (issued in a currency other than that of the issuing country), not by geography.
Confusing Callable and Puttable bonds — Callable gives the ISSUER the right to redeem early; Puttable gives the INVESTOR the right to sell back early.
Thinking FCCB is equity — it is debt that can be converted to equity; until conversion, it remains a bond with interest obligations.
Confusing Drop Lock Bond with a Callable Bond — Drop Lock automatically converts to fixed rate when rates fall below a threshold; Callable gives the issuer discretion to redeem.
Thinking Masala Bonds carry forex risk for the issuer — the currency risk in Masala Bonds is borne by the foreign INVESTOR, not by the Indian issuer.

Reference:

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Bonds — Classification (Callable/Puttable), Foreign Bond Types, and Indian Bond Types

Worked example

⚠️ Common exam mistakes