Debenture

15(Financial Instrument) What is the difference between Bonds and Debentures?

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• published: 30 Dec 2013
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Case 2 - Understanding a bond -Key Points - Goverment raising money by the public against security for it's expenses -eg oild bonds , REC bonds etc -Safe investment ,less rate of interest as compared to debenture - No ownership Now , come to bond ---this is raised by the Government to fund it's projects or meet certain expenses ....say it needs to import oil but because oil price has risen high , it wants to raise capital ---so it comes out to public with bonds which are nothing but a instrument top raise money against interest to be provided by government (against security )...public invest because the rate of interest is little more than the banks and treasury bonds are very safe investments and some of them are very competitively priced....say , you keep money 100 Rs with Axis bank at 5 % rate of interest annually , and at the same time govt comes out with a oil bond of 100 Rs which carries a coupon of 7 % yearly rate of interest , it's wise that you invest in this bond ...also bonds can be traded at the secondary market i.e you can sell/ buy bonds ,implying this market is very liquid . Usually the rate of interest offered by a bond is slightly lower than that of a debenture because , it is provided with collateral so in case govt defaults , public can always claim rights to this security(Think of bank giving loan against mortgaged home as asset ) In case of bonds as well as debentures , the public will get interest on principal irrespective of the financial health of the company Case 3 - Understanding a debenture -Key Points - Corporate raising money by the public without security (collateral) for it's expenses -eg -Less safe than bonds but safer than stocks ,more rate of interest as compared to bonds - No ownership This are issued by Company to finance it's projects ...say , iCompany Sesa Goa wants to expand certain XYZ business , and wants money for same , it decides to raise a certain part of that money via debentures .... Whilst doing so , it doesn't have to provide collateral security , but in order to compensate that , it has to provide higher rate of interest , So sesa say wants 100 Rs ,,,say it is ready to pay interest at 9 % annually(Highe rthan bond , because this is with no collateral ) Mechanism - , it will issue a debenture for 100 Rs without any collateral security ...when you lend sesa Goa 100 Rs(Buy this debenture ) , it is under obligation to pay you yearly 9 Rs as interest annualy .... At the end of the year considering the period of holding 1 year , you get 9 Rs interest and 100 Rs prinicipal amount which you lended ..... Note here , in case sesa Goa goes bankrupt , you have no collateral to demand ....however note , that it is still safer than stock because unlike stock which is only looked after everything else is exhausted , meeting debenture holder amount comes much higher in the priority list ......... Note that ,students often miss the big picture ----what are stocks , debentures and Bonds -----this is basically money being raised by the public----why do companies , govt raise money from public and not bank -----consider this , when raising money from public as stock , they have no obligation to them -----(yes the company if does well than offer public more rate of interest than the bank , but company is under no obligation .....) Also , why they raise money in terms of bonds and debentures ----firstly if they raise money from banks , they have to pay much higher rate of interest and also companies often go for a mix of debt instruments - some equity , some debentures ,some loans....but overall , the comfort of borrowing from the public without security and less obligation in terms of interest to match in comparison to bank lended loans are the major reasons ( Note - in Bonds ,govt does offer security , however rate of interest is low ----if govt raised money from bank , they will have to pay more interest in comparision to the interest they have to pay to public when they raise bonds which public invest in ) Summary -Since this are all ways to raise money , they are called debt instruments .Briefly securities means stocks /shares , bonds , debentures .... So , when you hear the word debt instrument or securities next time , dont get confused --rather start dancing in joy Cheers , Amlan Dutta