Debentures are debt instruments. Companies borrow from debenture-holders and generally offer a fixed rate of interest to such investors. Most debentures are redeemed after a specified period. The period could be short (less than 18 months) or long depending on the terms of issue. In some cases, companies also pay a premium on maturity.
Investors can subscribe to public issue of debentures by companies or buy debentures from the secondary market. In view of the fixed returns from these securities, prices of debentures are generally much less volatile relative to shares. Investors earn interest and capital gain (difference between the purchase price and the sale price or if held till redemption, the difference between purchase price and the redemption price).
Yields on debentures could be higher or lower than the specified rate of interest depending on the correlation between face value and market value. For example, assume that a Rs 100 debenture carrying 15% interest is bought for Rs 90. The price paid is Rs. 90 whereas the interest earned is Rs. 15. This would translate to a yield of 16.67%.
In the above example, the investor would get back Rs 100 from the company (face value) if he holds the debentures up to maturity. Hence, apart from the interest yield of 16.67%, he would also gain Rs 10 by way of capital gain. When this capital gain is also considered for computing the yield, it is termed as Yield to Maturity (YTM).
Liquidity in debentures is unfortunately low in the Indian markets in view of the lack of interest in these instruments so far. Very few debentures are actively traded on stock exchanges.
An investor need not be actively involved in investment management, except to the extent of keeping basic track of companies, which might be performing badly and could fail to fulfill its interest or repayment obligations.
Debenture prices are dependent on the face value of these instruments. The most common face value is Rs 100. Hence, even small amounts of Rs 10,000 can be invested in debentures.
Public Sector and Financial Institutions Bonds
Various bonds are floated from time to time by public sector undertakings as well as Development Financial Institutions. Most bonds offer attractive schemes like monthly interest, quarterly interest, various redemption options, deep discount bond options, etc.
A deep discount bond is a long-term bond where the initial amount invested keeps growing based on the interest accumulated on the principal amount. Bond prices are dependent on the face value of these instruments. An investor need not be actively involved in investment management.
RBI Tax Free Bonds
RBI Tax Free Bonds are special bonds issued by the RBI offering tax-free facility.
The rate of interest in such bonds is generally lower than regular bonds (around
8.5%) and hence will attract only high taxpayers. These bonds tend to be long-
Term instruments.RBI Tax free bonds are very safe as they come from the country’s central bank. Returns from the bonds are steady.
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