Bonds and Debentures
Bonds and debentures are debt instruments that companies and governments use to raise capital. Investors who purchase these instruments essentially lend money to the issuer in exchange for periodic interest payments and the return of the principal amount at maturity. While both bonds and debentures represent debt, there are some distinctions between the two.
Bonds
Bonds are debt securities issued by corporations, municipalities, or government entities to raise capital. They represent a promise to repay the principal amount (face value) at maturity and periodic interest payments to bondholders.
Secured and Unsecured:
Bonds can be either secured or unsecured. Secured bonds are backed by specific assets of the issuer, providing an additional layer of protection for bondholders. Unsecured bonds, on the other hand, are not backed by specific collateral.
Types of Bonds:
Government Bonds:
Issued by governments to fund public expenditures. Examples include Treasury bonds issued by the U.S. government.
​
Corporate Bonds:
Issued by corporations to fund business operations or expansion.
Municipal Bonds:
Issued by municipalities, such as cities or states, to fund public projects like infrastructure development.
Interest Payments: Bondholders receive regular interest payments, usually semiannually, based on the fixed or variable interest rate specified in the bond's terms.
Maturity Date:
Bonds have a predetermined maturity date at which the issuer repays the principal amount to bondholders. Maturities can range from a few years to several decades.
Market Price:
Bond prices can fluctuate based on changes in interest rates and the perceived creditworthiness of the issuer. When interest rates rise, bond prices tend to fall, and vice versa.
​
​
Sovereign Gold Bonds
Sovereign Gold Bonds (SGBs) are financial instruments issued by the Government of India, allowing investors to invest in gold in a paper or electronic form rather than owning physical gold. These bonds are part of the government's efforts to mobilize the idle gold held by households and institutions in the country. Here are key features of Sovereign Gold Bonds:
Issuing Authority:
Sovereign Gold Bonds are issued by the Reserve Bank of India (RBI) on behalf of the Government of India.
Underlying Asset:
The underlying asset for Sovereign Gold Bonds is physical gold. Investors receive returns linked to the prevailing market price of gold.
Denomination:
The bonds are issued in denominations of grams of gold, providing investors with the flexibility to invest in gold in small quantities.
Interest Rate:
Sovereign Gold Bonds offer an annual interest rate, which is fixed and payable semi-annually. The interest is credited directly to the investor's bank account.
Tenure:
The tenure of Sovereign Gold Bonds is usually eight years, with an exit option after the fifth year. Investors can choose to exit the investment on interest payment dates.
Tax Implications:
Interest income on Sovereign Gold Bonds is taxable as per the Income Tax Act, 1961. However, the capital gains tax arising at redemption is exempt for individuals if the bonds are held until maturity.
Tradability:
Sovereign Gold Bonds are tradable on stock exchanges, providing investors with liquidity and the option to exit before maturity.
Eligibility:
Individual investors, Hindu Undivided Families (HUFs), trusts, universities, and charitable institutions are eligible to invest in Sovereign Gold Bonds.
​
KYC Requirements:
Investors need to comply with Know Your Customer (KYC) norms when applying for Sovereign Gold Bonds.
​
Subscription Periods:
The government periodically opens subscription windows for Sovereign Gold Bonds, allowing investors to apply for the bonds during specific periods.
​
Nomination Facility:
Investors can nominate individuals in their investment application, facilitating the smooth transfer of the bonds in case of the investor's demise.
​
Collateral for Loans:
Sovereign Gold Bonds can be used as collateral for loans, helping investors unlock liquidity without selling their gold holdings.
​
Sovereign Gold Bonds provide investors with an alternative to physical gold investment, offering the benefits of safety, liquidity, and interest income. However, it's essential for investors to carefully read the issuance guidelines, understand the terms and conditions, and consider their investment objectives and risk tolerance before investing in Sovereign Gold Bonds. The features and terms of Sovereign Gold Bonds may be subject to change, so it's advisable to check with the relevant authorities or financial institutions for the latest information.
​
Debentures
Debentures are a type of unsecured debt instrument issued by corporations and governments. Unlike secured bonds, debentures are not backed by specific assets, relying on the general creditworthiness of the issuer.
​
Security:
Since debentures are unsecured, they do not have specific collateral backing them. Instead, they are supported by the issuer's overall creditworthiness and ability to generate sufficient cash flow to meet debt obligations.
Interest Payments:
Similar to bonds, debenture holders receive regular interest payments based on the terms specified in the debenture agreement.
Maturity Date:
Debentures have a maturity date at which the principal amount is repaid to debenture holders. The maturity period can vary depending on the terms of the debenture.
Ranking in Case of Default:
In the event of a default by the issuer, debenture holders have a claim on the company's assets after secured debt holders but before equity shareholders. However, they are subordinate to secured debt holders.
In summary, both bonds and debentures are debt instruments used to raise capital, but the key distinction lies in the security backing the instruments. Bonds can be secured or unsecured, while debentures are typically unsecured. Investors in both types of instruments receive regular interest payments and the return of the principal amount at maturity. The choice between bonds and debentures depends on the issuer's needs and the risk tolerance of investors.