Bonds and Debentures


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Bonds and Debentures

  1. 1.  a bond is an instrument of indebtedness of the bond issuer to the holders. It is a debt security, under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and/or to repay the principal at a later date, termed the maturity Interest is usually payable at fixed intervals (semiannual, annual, sometimes monthly). Thus a bond is a form of loan or IOU: the holder of the bond is the lender (creditor), the issuer of the bond is the borrower (debtor), and the coupon is the interest. Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure.
  2. 2.  Bonds and stocks are both securities, but the major difference between the two is that (capital) stockholders have an equity stake in the company (i.e. they are owners), whereas bondholders have a creditor stake in the company (i.e. they are lenders). Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks may be outstanding indefinitely. An exception is an irredeemable bond, such as Consols, which is a perpetuity, i.e. a bond with no maturity
  3. 3.  A debenture is a document that either creates a debt or acknowledges it, and it is a debt without collateral. In corporate finance, the term is used for a medium- to long- term debt instrument used by large companies to borrow money. In some countries the term is used interchangeably with bond, loan stock or note. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the companys capital structure, it does not become share capital. Debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the companys general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the companys financial statements
  4. 4. Itis a debt security, under which the issuerowes the holders a debt and, depending onthe terms of the bond, is obliged to pay theminterest (the coupon) and/or to repay theprincipal at a later date, termed the maturity. Interest is usually payable at fixed intervals(semiannual, annual, sometimes monthly).
  5. 5. Principal Nominal, principal, par or face amount — the amount on which the issuer pays interest, and which, most commonly, has to be repaid at the end of the termMaturity The issuer has to repay the nominal amount on the maturitydate. As long as all due payments have been made, the issuer has no further obligations to the bond holders after the maturity date. The length of time until the maturity date is often referred to as the term or tenor or maturity of a bond.Coupon The coupon is the interest rate that the issuer pays to the bond holders. Usually this rate is fixed throughout the life of the bond. Interest can be paid at different frequencies: generally semi-annual, i.e. every 6 months, or annualYield The yield is the rate of return received from investing in the bond
  6. 6. 1. Zero-Coupon Bonds: This is a type of bond that makes no coupon payments but instead is issued at a considerable discount to par value. For example, lets say a zero-coupon bond with a $1,000 par value and 10 years to maturity is trading at $600; youd be paying $600 today for a bond that will be worth $1,000 in 10 years. The issue price of Zero Coupon Bonds is inversely related to their maturity period, i.e. longer the maturity period lesser would be the issue price and vice-versa. These types of bonds are also known as Deep Discount Bonds.
  7. 7. 2. High-Yield Bonds: High yield (non-investment grade) bonds are from issuers that are considered to be at greater risk of not paying interest and/or returning principal at maturity. As a result, the issuer will offer a higher yield than a similar bond of a higher credit rating and, typically, a higher coupon rate to entice investors to take on the added risk.3. Corporate Bonds: These are issued by large corporations and have higher yields because there is a higher risk of a company defaulting as compared to government bonds.
  8. 8. 4. Government Bonds: These are the bonds issued by government in its own currency. They are usually referred to as risk-free bonds. Bonds issued by national governments in foreign currencies are referred to as sovereign bonds.5. Convertible Bonds: The holder of a convertible bond has the option to convert the bond into equity (in the same value as of the bond) of the issuing firm (borrowing firm) on pre-specified terms. Convertible bonds may be fully or partly convertible. For the part of the convertible bond which is redeemed, the investor receives equity shares and the non-converted part remains as a bond.
  9. 9. 6. Inflation-indexed (or inflation-linked) Bond: It provides protection against inflation, and is designed to cut out the inflation risk of an investment.7. Extendible and Retractable Bonds: Extendible and Retractable bonds have no fixed maturity date. While the maturity period of extendible bonds can be extended on the demand of the buyer of these bonds, the maturity period of retractable bond can be reduced and the principal amount returned to the buyer if he feels so.
  10. 10. 8. Floating Rate Bonds: Floating Rate Notes are bonds in which interest rate depends on the interest rate prevailing in the market. The interest rate paid to the bondholder at regular intervals comprises of the interest rate prevailing in the market and ‘spread’, which is a rate that is fixed when the prices of the bond are being fixed and it remains constant till the maturity period of the bond.9.Perpetual Bonds: Perpetual Bonds, which are also known as the name of Consol, are the bonds which have no maturity period and keep on paying interest to the investors regularly. The issuer of Perpetual Bonds is not required to redeem these bonds. They are generally treated as equity and not as loan / debt.Some other Types of bonds: Asset Backed Securities, subordinated bonds, Bearer Bonds, Municipal Bonds, Lottery Bonds, War Bonds.
  11. 11. 1. SECURITY Secured/ Mortgage Unsecured2. REDEMPTION Redeemable Irredeemable
  12. 12. 3. RECORDS• Registered• Bearer4. CONVERTIBILITY• Convertible• Non-convertible5. PRIORITY• First• Second
  13. 13.  Investorsconsider debentures/bonds as a relatively less risky investment, therefore it requires a lower rate of return. Interest payments are tax deductible. The floatation costs on debentures/bonds is usually lower than floatation costs on common shares
  14. 14.  No voting rights therefore no dilution of ownership. Debenture/bomd holders do not participate in extraordinary earnings of the company. Thus their payments are limited to interest. Duringperiods of high inflation, debenture/bond issue benefits the company. Its obligations of paying interest and principal, which remain fixed, decline in real terms.
  15. 15.  Theirissue results in legal obligation of paying interest and principal, which, if not paid can force the company into liquidation. Theirissue increases the firms financial leverage and reduces its ability to borrow in future. They must be paid at maturity and therefore at some point, it involves substantial cash outflows. Theymay contain restrictive covenants which may limit the firms operating flexibility in future.