Introduction

When considering investment choices in India, fixed-income options, such as bonds and debentures, are common ways to earn regular returns. Bonds and debentures both serve as a way to raise funds for a company and pay interest to the investor at defined periods, but there are differences related to safety, risk, and structure. Understanding the differences between bonds and debentures will give Indian investors a more robust understanding of making a more informed decision in line with their investment purpose. This article describes what a bond is, what a debenture is, and how they are similar and different.

What is a Bond?

A bond is a fixed-income instrument issued by organisations like the Indian government, public sector undertakings (PSUs), or large corporations to raise funds from investors. When you acquire a bond, you are lending money to the issuer, which will repay your original cash at a future date and pay interest payments (or coupon payments). Generally, bonds are integral to conservative investment portfolios, as they are relatively safe.

Open Demat Account and Start Trading!

Characteristic of Bonds

Security: Many bonds will have some backing. This backing could be a specific asset or credit risk related to the issuer's ability to repay. For many government bonds, such as Indian Government Securities (G-secs), the backing is sovereign credit.

Risk profile: Bonds have a lower risk profile than other asset classes (particularly bonds issued by the government, which is considered sovereign credit).

Interest rate: Bonds can have either fixed interest rates or floating rates of interest, which can provide specific, assured cash flows.

Issuers: Mainly private or public companies; the government does not typically issue debentures in India.

Several different types of bonds:

• Government Bonds: Government bonds are issued by the Reserve Bank of India (RBI) and are generally low risk. An example of a government bond is a 7.1% GOI Bond 2034.

• Corporate Bonds: Corporate bonds are issued when companies wish to raise money to develop expansion plans or for current operational procedures.

• Convertible Bonds: Convertible bonds allow bondholders to convert the bonds into equity shares upon maturity.

• Zero-Coupon Bonds: Zero-coupon bonds are issued at a discount to their face value (par value) and do not include any periodic interest paid. They only have face value.

• Tax-Free Bonds: The interest earned from tax-free bonds doesn't have a tax liability, making them a long-term bond.

What is a Debenture?

A debenture is a type of debt security that lets businesses raise money from the public. When you buy a debenture, you lend the issuer money for some time, receive interest at intervals, and then the principal when the debenture matures. Debentures are different from bonds because they provide companies with an unsecured method of borrowing based primarily on the creditworthiness of the issuer of the debenture rather than any collateral.

Debenture features

- Issuers: Companies (private or public sector companies) and occasionally the government.

- Risk: In many situations, debentures have more risk due to no collateral backing the debenture, but there can still be secured debentures.

- Interest rates: Debentures have a higher risk; therefore, like bonds, they usually bear higher interest rates.

- Convertible Option: Debentures can be convertible (equity) or non-convertible.

Comparison between Debentures and Bonds

The difference between debentures and bonds differs based on assets, issuer, duration, liquidity, salvaging, and guarantees, summarised below:

Which One Should You Choose?

Your choice between a bond and a debenture depends on your risk tolerance, time horizon, and objectives.

Select Bonds if you are risk-averse, only want government-backed securities, or want to generate a stable income portion with low risk. Ideal examples of this are G-secs or tax-free bonds issued by PSUs, as they suit risk-averse Indian investors.

Select Debenture if you understand the risk-return relation and are willing to incur higher risk to aspire for higher returns; you are comfortable with the financial stability of the issuing company, or if you want exposure to the corporate economy and profitability expansion.

Conclusion

In summary, understanding bonds and debentures is essential to understanding fixed-income securities in India. Understanding the difference between bonds and debentures can help you make appropriate choices depending on your financial goals, whether that is safety or yield.

Similar Topics - Debentures explained - Types, Features and Benefits | What are Tax-free bonds and how do they work? | The benefits of investing in Bonds