By Sunil K Parameswaran
Bonds are not as higher profile as most blue-chip stocks, and consequently most investors are not conscious of them. Bonds are an option to stocks for corporations in search of to raise capital. They represent a guarantee by the issuer to spend periodic interest to the holder, and to repay the principal at a pre-specified maturity date. There are exceptions. Zero coupon bonds do not spend periodic interest, and the sum of the principal and interest is paid out at maturity. Perpetual bonds have no maturity date. They will spend interest forever and will in no way repay the principal.
Companies use bonds to acquire capital without having diluting the stake of the shareholders. They are an option to bank loans, which are an option supply of debt capital for corporations. Bonds present leverage. That is, due to the fact they spend a fixed price of return, the price of return is magnified for equity shareholders. However, leverage is a double-edged sword, that is, each constructive and adverse returns are magnified.
Interest on bonds is a tax deductible expense for a firm, in contrast to dividends on shares, and consequently delivers the issuing firm with a tax shield. Thus, debt capital is usually regarded to be less expensive than equity capital for the issuer.
Secured or unsecured bonds
Bonds might be secured or unsecured. The former are backed by precise collateral, such as land, buildings, or plant and machinery. If the issuer can’t make a promised payment, the holders of secured debt can have the collateral liquidated to recover what is owed to them. Unsecured debt holders can only hope that the issuer will have sufficient sources when the time comes for repayment. In the US, secured debt is named a bond and unsecured debt is termed as a debenture. In India we use the terms interchangeably. Consequently, if a person mentions the word debenture in India, we need to have to inquire regardless of whether it is secured or unsecured.
If a firm is liquidated, the pecking order for payments is as follows. Secured debt holders are paid initial, followed by unsecured debt holders, who are followed by preference shareholders, if any. Obviously, the equity shareholders are the final to be paid, if there is a residue, and are consequently identified as residual claimants.
Equity shares are usually listed and traded on stock exchanges. While some bonds are traded on stock exchanges, the majority trade more than the counter (OTC), in a market place created by dealers. Some debt securities can’t be traded and are mentioned to be non-negotiable. For instance, a National Savings Certificate (NSC) that is utilized by Indians for tax saving purposes, and fixed deposit receipts, held by men and women can’t be traded. If a individual desires revenue, he can pledge his NSC and borrow, but an NSC or fixed deposit receipt can’t be endorsed and transferred to an additional individual.
Unlike a stock owner who might sell to capture a capital achieve, most bondholders will hold on to them till maturity, although collecting the periodic interest payments.
The writer is CEO, Tarheel Consultancy Services