Bonds & Debentures Basics

Madhura OakProject Manager

Intellect Design Arena Ltd.

Debt Instrument

A Debt instrument also called as a debt security is a contract between borrower and lender in which the lender lends money to borrower on predefined rate of interest called as coupon rate, maturity and principal amount also called as par value or face value of the bond.

Debt instruments are traded in market. They are issued in primary market and can also be purchased from secondary market. They can be held upto maturity. Callable bonds can be redeemed prior to maturity.

Types of Debt Instruments

Debt Instruments

Bonds & Debentures Money Market Instruments

Long Term Medium to Short Term

Treasury Bills

Certificate of Deposits

Commercial Paper

Repurchase Agreements

Notes

Bonds & Debentures

Debt instruments issued by central/state governments and public sector companies are called bonds and those issued by private sector companies are called debentures.

Bonds issued by the central government are also called as gilts. In India, they are also called as GOI securities or G-secs.

Price of Bonds/Debentures

Government bonds have a face value of Rs. 100.

The market price of the bond/debenture may vary. They are purchased at market price from secondary market.

Coupon Rate

Coupon rate may be fixed rate or floating rate.

In case of fixed coupon rate, the rate of interest remains same throughout the investment period.

In case of floating coupon rate, the rate of interest varies periodically through the tenor of investment.

Returns of Bonds/Debentures

Coupon = Face value * coupon rateThe coupon is paid annually, semi-annually, quarterly or

monthly. Coupon on GOI securities is paid semi-annually i.e. after every 6 months.

On maturity, the investor gets the fixed amount mentioned on the bond irrespective of its market price.

The coupon is issued to the investor irrespective of whether the company makes profits unlike shares where the dividend is paid only during profit.

Ownership

Holders of debt instruments are not owners unlike share holders.

Difference between Bonds & Debentures

Bonds Debentures

Secured Unsecured

Coupon rate is lower Coupon rate is higher as the default risk is higher

Issued by State/Central Government or PSU companies

Issued by private sector companies

Convertible bonds & debentures

Bonds & debentures issued by companies may be completely or partially convertible into shares.

Credit Rating of Companies issuing Bonds/Debentures

Source: Investopedia, CRISIL

Moody’s S&P/Fitch CRISIL Grade Quality

AAA AAA AAA Investment Highest

AA AA AA Investment High

A A A Investment Strong

BAA BBB BBB, BB Investment Medium

BA, B BB, B B Junk Speculative

CAA, CA, C

CCC, CC, C

C Junk Highly Speculative

C D D Junk In Default

Why should individuals invest in Bonds/Debentures

• Steady source of income

• Safe Investment in case of bonds & debentures of companies with good credit rating

• Capital appreciation in case of investment in riskier companies.

Thank you!