How do companies raise funds without compromising on their ownership? When the government raises funds, there is no concept of parting ownership with investors. So, how does the government raise funds?
Yes, they use debt financing in such cases.
While equity makes the investor a part owner, debt treats the investor like a lender.
Debt is a form of loan that corporations and the government borrow from the public in exchange for interest payment and a promise to repay the principal after the agreed term.
Debentures and bonds fall under the purview of debt securities.
What are bonds?
Bonds are securities issued by the government and corporations in the form of debt, to meet their financial needs.
Investors here play the role of lenders, and the corporation or government issuing the bonds are borrowers.
Bonds are usually secured loans as they are secured by physical assets.
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Features of bonds
Important features to examine before putting money into bonds:
- Interest rate – Since bonds are a type of loan, it involves interest payment. A fixed percentage calculated on the face value is paid as interest at regular intervals.
- Issue price and face value – Issue price is the price paid by the investor while purchasing the bond. Face value is the price the issuer pays back during redemption.
When both of them are equal, the bonds are at par.
When issue price > face value, the bonds are at a premium.
When issue price < face value, the bonds are at a discount.
- Maturity date – This represents the term or duration of the loan. The principal must be returned after the bond matures.
- Yield – The total return an investor earns upon investing in the bond.
- Liquidity – Bonds are traded on the stock exchange. It is essential to understand how easy or difficult it is to sell a particular bond in the market.
How to invest in bonds?
Corporate bonds to raise capital are first issued in the primary market, where investors can directly buy them from corporations. Further trading of these bonds takes place in the secondary market.
Investors must have demat accounts to invest in these bonds.
Bonds issued by the state and local government authorities are called Municipal bonds. Investors can buy these from the primary market during a specific time allocated for retail investors. They can also buy it from the secondary market after creating a DEMAT account.
The central government bonds can be bought through various sources like gilt mutual funds, brokerage firms, RBI Direct, Post office or the stock exchange.
Investors must open an account in the Retail Direct Gilt (RDG) portal to buy bonds from RBI Direct.
What are debentures?
Debentures are one of the types of bonds issued by corporations and the government.
These are unsecured loans as they do not have any collateral attached.
Debenture holders cannot exercise any right on the company’s assets. Investing in debentures is based on the creditworthiness of the issuer.
Features of debentures
While the main characteristics of debentures are the same as bonds, debentures have some additional features as they are issued in different types:
- Secured debentures – While the normal debentures are not collateralised, only the secured debentures have collateral.
- Unsecured debentures – These are the regular debentures which are not secured. The creditworthiness and goodwill of the company play critical roles in attracting investors.
- Redeemable debentures – These debentures are valid until the maturity date, after which they are redeemed.
- Irredeemable debentures – These debentures do not have a maturity date. They will be redeemed only during the company’s liquidation.
- Convertible debentures – Some debentures can convert into equity after a specific time.
Based on the conversion, they are further divided:
- Partially convertible – A portion of the total debentures can be converted to equity. The issuer decides the quantity and date of conversion.
- Fully convertible – All units of the debentures can convert into equity.
- Optionally convertible – Conversion into equity based on the issuer’s decision.
- Non-convertible debentures – These will remain debt securities throughout their term and will not be converted into equity.
How to invest in debentures?
Debentures, like bonds, can be bought directly from the issuer – corporations or government. Debentures are traded in the secondary market hence, they can be bought on the stock exchanges as well.
It is essential to be clear about the features you are looking for while investing in debentures. All debentures, except secured debentures, are unsecured. Similarly, all debentures, except convertible debentures, are non-convertible.
Difference between bond and debenture
|Bonds are secured loans against collateral.||Debentures are unsecured loans and are not supported by any collateral.|
|Bonds are less risky.||Debentures have a greater risk involved.|
|Bonds are generally for a longer term than debentures.||The maturity period of debentures is shorter than that of bonds.|
|Bonds offer a lower rate of interest as they are secured loans.||Better interest rates than bonds as debentures are riskier.|
|Bondholders get priority in interest and principal payment in case of liquidation.||Debenture holders stand after bondholders in the event of liquidation.|
Below is a snippet of some of the bonds listed on the National Stock Exchange (NSE) as of 04 September 2023.
The Goa International Airport has recently announced to raise ₹2,480 crores through debentures.
- Debenture type: Non-convertible debenture
- Term: 5 years
- Interest rate: 10.25%
Debentures and bonds are debt securities issued by large corporations and government bodies to raise funds.
The investors are only lenders here and do not get any equity or voting rights in the company unless they invest in convertible bonds or debentures.
Though they do not get the benefits of an equity shareholder, debt securities are more stable in generating recurring income for investors.
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