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Bonds & Debentures

A debt instrument represents a contract whereby one party lends money to another on pre-determined terms about rate and periodicity of interest, repayment of principal amount by the borrower to the lender. In the Indian securities market, the term ‘bond’ is used for debt instruments issued by the Central and State governments and public sector organizations and the term ‘debenture’ is used for instruments issued by private corporate sector. Bonds and debentures represent long-term debt instruments.

1) Government Securities (G-Secs)

 Debt securities issued by the central government, state government and quasi-government agencies are referred to as government securities or gilt-edged securities. They are issued by the government of India through auctions. They represent borrowings by government of India. These are medium to long-term interest bearing obligations issued through the RBI by the government of India and state governments. The RBI decides the cut-off coupon (interest rate) on the basis of bids received during auctions. Investors can participate in these auctions through specified banks and Primary Dealers (PDs). A list of such banks and PDs is available on RBI’s website: rbi.org.in. Since, investment in G-Secs involves a high capital outlay, so it is suggested to the retail investors to participate in it through mutual funds in the form of Gilt Funds.

Government securities are classified in two ways:

 1a) Treasury Bills (T-Bills)

 T-Bills are short-term obligations, generally up to one year, issued through the RBI by the government of India at a discount. At present, the Government of India issues three types of treasury bills through auctions, namely, 91-day, 182-day and 364-day treasury bills. The yield is determined on the basis of bids tendered and accepted. As T-Bills are issued by the government and the government has high credit worthiness in any market, so it is not expected to default on its payment obligations. Consequently, they are considered to be safe and liquid investment instruments.

 1b) Dated Securities

 Government paper with tenor beyond one year is known as dated security. At present, there are Central Government dated securities with a tenor up to 30 years in the market.

 2) Public Sector Undertaking Bonds (PSU Bonds)

 Public Sector Undertakings (PSUs) issue debentures that are referred to as PSU Bonds. PSU Bonds are medium or long-term obligations issued by public sector companies in which the government shareholding is either greater than or equal to 51%. There are two varieties of PSU Bonds: taxable bonds and tax-free bonds. PSU bonds are generally not guaranteed by the government and are in the form of promissory notes transferable by endorsement and delivery.

 

 3) Private Sector Debentures

 

 A debenture is a document which either acknowledges or creates a debt. Debentures hold an important position in the overall capital structure of most companies. Whereas equity and preference capital represent owners’ funds, debentures represent borrowed funds.

 

Basically, there are three types of debentures that a company can offer:

 

-  Fully Convertible Debentures: These are converted fully into equity shares in one or more installments at a specified price or at a price to be worked out later based on certain specified guidelines, indicated in the prospectus or letter of offer.

 

-  Partly Convertible Debentures: These have two portions: one part is converted into equity shares and another is retained as debentures carrying fixed rate of interest.

 

-   Non-convertible Debentures: These do not contain an option for conversion.

 4) International Bonds

 

 These bonds are issued overseas, in the currency of a foreign country which represents a large potential market of investors for the bonds. Bonds issued in a currency other than that of the country which issues them are usually called Eurobonds. However, now they are called by various names depending on the currency in which they are issued. Euro-dollar bonds are US Dollar-denominated bonds issued outside the United States. Euro-yen bonds are Yen-denominated bonds issued outside Japan. Some international bonds are issued in foreign countries in currency of the country of the investors. The most popular of such bonds are Yankee bonds and Samurai bonds. Yankee bonds are US Dollar denominated bonds issued in U.S. by a non-U.S. issuer and Samurai bonds are Yen-denominated bonds issued in Japan by non-Japanese issuers.