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Bonds and Debentures
A Debenture, as well as a Bond, is issued by the companies as a debt instrument to raise capital. In general, Bonds issued by agencies of government or by a large corporation. Debentures are issued by public companies to raise capital from the public. In this blog, we will share the following details.
What are bonds?
What are Debentures?
Characteristics of Debentures and bonds?
Difference Between Bonds and Debentures?
What is the difference between loan and debenture?
What are bonds?
Bonds are defined as tradable assets issue by a corporate or government as a debt instrument to raise money from the public. When governments and corporations want to raise money, they will raise the bond and pay interest to the buyers for the units of the bond they purchased. By buying a bond, the investor giving the issuer a loan. The organization raises the bonds to need to pay back the loan on a specific date and also needs to pay periodic interest to the buyers.
- A bond certificate consists of the details of the bond end date, rate of interest, and its payment details.
- Maturity dates of a Bondis the date on which the principal amount needs to pay back in full to the buyer.
- Bond investment is a fixed income instrument, as bonds paid a fixed rate of interest to the
- Also now floating or variable interest rates bonds are common in the market.
Features or Characteristics of Bonds
Bonds have some common basic characteristics which are the following:
Face value is the amount of money the bond is worth at the time of maturity. The interest payment is calculated with reference to the face value.
The coupon rate is the rate of interest of the bond. The bond issuer needs to pay the interest to the buyer on the basis of the face value of the bond. The coupon rate is expressed as the percentage face value of the bond.
The coupon date is the date of payment of interest by the bond issuer. Interest payments need to made in any periodic interval, which can be decided by the bond issuer. In general, payment will be semiannual.
The maturity date is the date of maturity of the bond I.e. date on with the bond will expire. On the maturity date, the bond issuer needs to pay the face value of the bond to the bondholder.
The issue price is the price on which a bond is actually issued to the public. The issue price is the price at which originally the bond issued into the market.
Types of Bonds
There are many different varieties of bonds available for investors in the market. Bonds can be separated by the interest rate and other few attributes.
Zero-coupon bonds are bonds that do not pay interest to the bondholders. Instead of paying interest, these bonds are issued at a discount price to the public. These bonds generate a return only once the bonds matured, as the bondholder gets paid the full face value, which will be much higher than the issue price.
Convertible bonds are the debt instruments issued by the corporate. Convertible bonds allow bondholders to convert their debt into equity at some point. The convention will only possible by meeting certain conditions.
The convertible bond may have lower interest payments. Once the investors converted their bonds, the company will not pay any more interest or the principal of the bond on maturity. The investor can sell the equity in the share market at any time if the company is listed. If the company is successful the investors can book profit from stock selling.
A callable bond is a type of convertible bond. A callable bond is a bond which the company “called” back before it matures. A callable bond is likely to be called at any time, a callable bond is riskier for the bond buyers.
A Puttable bond is a type of bond which allows the bondholders to sell back the bond to the company before the maturity date. This is valuable for investors who want to get the principal back before the bond falls in value. In general Puttable bond will have a lower coupon rate. The bond issuer makes the Puttable bonds to get the initial loan for the business. A Puttable bond usually trades at a higher value than a normal bond as it is more valuable to the bondholders.
The possible combinations of embedded convertibility rights, puts, and calls, in a bond, are endless and unique. There isn’t a strict standard for each of these rights. Some bonds will contain more than one kind of option like convertibility rights, puts, and calls. Individual investors need to select individual bonds or bond funds based on their investment goals.
How to buy bonds?
Small investors can buy government bonds using the mobile or web app of the National Stock Exchange (NSE). Also, bonds can be purchased through the broker’s applications. Bonds can be purchased either Competitive bidding or non-Competitive bidding process. Most of the government bonds are tax-free in nature.
- An investor can check the list of government bonds on the NSEgoBID apps.
- An investor can also buy bonds from the secondary market and it can be sold to another buyer just like equity.
What is Debentures?
The Debenture is a medium to a long-term debt instrument, used to borrow money by large companies from the public. A debenture is a certificate of loan which evidencing the fact that the borrower is liable to pay back a specified amount of principal and interest to the debenture holder. Debenture holders will not become shareowners of the borrower and have no rights to vote in the company’s general meetings. In the case of liquidation of the company, a debenture will get paid first before the other shareholders.
- A debenture is a financial instrument used by a lender to provide capital to companies.
- In the event of a payment default, debentures enable the lender to take ownership of the borrower’s assets and sell them off to recover the loan amount.
- Debentures are free transferable to another lender.
- A debenture is not backed by any collateral, only by the creditworthiness of the issuer.
- Debentures are usually had, greater than 10 years of tenure.
- Some debentures issued by corporations can convert to equity shares while others cannot.
Features or Characteristic of Debentures:
Debentures have some common basic features or characteristics which makes them stand out from equity and preference shareholders: The Basic characteristic of debentures are listed below.
A company issued debentures in the form of a certificate. In general, debentures are an acknowledgment of indebtedness. A debenture is a written promise, which states, the company acknowledges it is a loan or debt.
A company issued debentures under the company’s seal as it is one of a series issued a note to several lenders. A Debenture deed shows the amount of repayment and the rate of interest and the period.
A debenture deed will specify the date of issue and a particular period or the date of repayment by the company to the holders. In general, 10-20 years is the maturity period of debentures.
A debentures holder gets a charge on the undertaking of the company or parts of its entire property. A debenture holder, will not have any voting right in the company meetings. As The debenture holders are only creditors to the company, they will not hold any power to control the company’s operations.
Fixed-Rate of Interest:
A debentures holder will get a fixed rate of interest on the invested amount and they will get paid every financial year. As it is a fixed rate, debentures also called fixed cost bearing capital.
Priority on the Income claim:
The debenture holders have the right to get a fixed rate of interest at every financial year-end. The debenture holders have a legal right to get priority on the income of the company. The company will have to pay interest to debentures holders first over the equity and preference shareholders.
Priority claim on assets:
During the time of liquidation or reorganization of the company, the debenture holders will get priority over the preference shareholders and equity holders in respect of their claim on assets.
Appointment of the trustee:
Company Appointments a trustee, during they sell a large number of debentures to the general public. The financial institutions or a Bank can work as a trustee to ensure that, contractual obligations of borrowing will be fulfilled.
Types of debenture
Debentures are of 2 types, Fixed charge, and Floating charge.
Fixed charge debenture is taken against the tangible asset of the borrower such as property. Without the lender’s consent, the borrower would not be able to sell the asset.
Floating charge debenture is usually taken against the assets such as intellectual property, shares, and the raw materials holding of companies. The borrower can sell floating charge debentures without the intervention of lenders. As the value of shares changes over time, it is called floating charges debentures.
Convertible and Nonconvertible Debentures:
Convertible debentures are bonds that can convert into equity shares after a specific period. Convertible debentures having the benefits of both equity and debt. Companies use debentures as fixed-rate loans instrument and pay interest to the holders. Holders of convertible debentures can be holding the loan until maturity or convert it into equity shares. Convertible debentures pay a lower interest rate than a fixed-rate investment.
Nonconvertible debentures cannot be converted into equity shares of the corporation. Nonconvertible debentures offer a higher rate of interest than convertible debentures.
Debenture as IOU
A debenture is a financial instrument in which issuers raise an IOU (abbreviated from the phrase “I owe you”) to the purchaser. An IOU is an informal document that acknowledges a debt owed between the issuer and purchaser and may be followed up with a formal agreement. An IOU is not a negotiable instrument, IOU does not specify repayment terms like time of repayment, it only specifies the debtor, the amount owed, and sometimes the creditor details. A debenture is a debt instrument that is unsecured by collateral hence only relies on the reputation of the issuer.
Difference Between Bonds and Debentures?
- Bonds are backed by the asset of the issuing corporation, but debentures are not.
- The interest rate for debentures is generally higher than bonds.
- Bonds are issued by Government agencies and Private organizations but Debentures are issued by public or private companies.
- The risk factor for bonds is lower than the debentures.
- For bonds, the interest amount never differs.
- For bonds, interest paid is not dependent on the performance of the issuer, but for debentures, it depending on the performance of the issuer.
- At the time of liquidation, the bondholders will get a higher preference.
- Bonds can’t convert to equity shares, but debentures can convert to equity funds.
What is the difference between loan and debenture?
In the case of loans, the lending institutions are banks or non-banking financial institutions to the public or to the companies, but in the case of debenture, the Public lends money to the company and gets a fixed rate of interest.
A bond and a debenture are financial instruments to borrow capital from the public. As a bond is backed by collateral, it is more secure than a debenture. The scope of earning is high with debentures. To invest in debentures, investors should have the capability to check the creditworthiness of the issuer. Bonds are a better choice for newbie earners even though both investment options have guaranteed returns.
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For those who have ready to take high risk and wants to earn profit in a short time, debentures are the best option.
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