Shares, Bonds & Debentures

In the capital market, shares, bonds, and debentures are fundamental instruments that companies and governments use to raise funds. These represent different types of securities – broadly categorized into equity (shares) and debt (bonds/debentures). It is essential for banking and finance exam aspirants to understand what each of these instruments signifies, their characteristics, and how they differ from one another.

Shares (Equity Shares)

A share represents a unit of ownership in a company. When an investor buys shares of a company, they become a part-owner (shareholder) of that company to the extent of their shareholding. Key features and types of shares include:

• Equity Share Capital: The most common type of share is an equity share (also known as ordinary share or common stock). Equity shareholders have voting rights in the company’s management decisions (e.g., electing the board of directors) and a residual claim on profits.
• Voting and Control: Equity shareholders typically have voting rights proportional to their shareholding. They collectively own the company, and major corporate decisions often require shareholder approval.
• Dividends: Equity shareholders may receive dividends, which are a portion of the company’s profits distributed to owners. However, dividends on equity shares are not fixed or guaranteed; they are declared at the discretion of the company’s board, usually based on profitability. In good years, dividends may be high; in lean years or if the company reinvests profits, dividends may be low or skipped entirely.
• Capital Gains: If the company grows and becomes more profitable, the market price of its shares typically rises, giving shareholders a capital gain if they sell at a higher price. Conversely, share prices can fall, meaning equity involves risk.
• Residual Claim: In the event of liquidation (company shutting down), equity shareholders have a residual claim on assets after all debts are paid off. This means they are the last to be paid (after debtholders, employees, taxes, etc.), which makes equity more risky in terms of security of investment.

Preference Shares

Apart from equity (common) shares, companies can also issue preference shares. These are a hybrid of equity and debt features:

• Preference shareholders usually do not have voting rights (or have limited voting rights) in general meetings.
• They are entitled to a fixed dividend rate (e.g., a 5% preference share gets 5% of its face value as dividend each year, if profits are sufficient).
• Crucially, preference shares have priority over equity shares for dividends and during liquidation. This means dividends to preference shareholders are paid out before any dividend to equity shareholders. In liquidation, preference capital is repaid (after debt but before equity holders get anything).
• However, since their dividend is fixed, they typically do not benefit from extra profits beyond that fixed rate, unlike equity shareholders who can get increasing dividends.
• Types of preference shares include cumulative (undeclared dividends accumulate to be paid later), convertible (can be converted into equity shares under certain conditions), etc.

Shareholder Rights & Benefits

Shareholders (especially equity shareholders) have certain rights like voting, receiving annual reports, participating in rights issues (opportunity to buy additional shares if the company issues more equity, usually at a discount), etc. They also may benefit from bonus shares (free additional shares given in proportion to holdings when a company capitalizes its reserves).

Issuer Perspective

For a company, issuing shares (equity) means raising capital without incurring debt or interest obligations. However, it dilutes ownership and profits among a larger base of owners. Equity is permanent capital (no repayment obligation), which can strengthen a company’s balance sheet, but shareholders expect growth and returns on their investment via share price appreciation or dividends.

Example: If XYZ Ltd. issues 1,00,000 equity shares and an investor buys 10,000 shares, that investor owns 10% of XYZ Ltd. They can vote in shareholder meetings, receive 10% of any dividends declared for all shares, and if the share price rises from say ₹100 to ₹150, they make a capital gain of ₹50 per share if they sell.

Bonds

A bond is a debt instrument representing a loan made by investors to the issuer. When you purchase a bond, you are effectively lending money to the issuer (which could be the government, a corporation, or any entity issuing the bond) in exchange for regular interest payments and the promise that the principal (face value) will be repaid at maturity. Key characteristics of bonds include:

• Issuer and Face Value: Bonds are issued by governments (central or state government bonds, also called government securities or gilts), municipal bodies (municipal bonds), and companies (corporate bonds). Each bond has a face value (par value), which is the principal amount the issuer agrees to repay at maturity. Common face values might be ₹100, ₹1,000, etc., depending on the bond.
• Coupon (Interest): Most bonds pay a fixed rate of interest known as the coupon rate. For example, a bond with ₹1,000 face value and 8% annual coupon will pay ₹80 interest per year (often split into semi-annual payments of ₹40 each, if interest is paid half-yearly). The coupon can also be floating (variable) or zero (see zero-coupon bonds below).
• Maturity: Bonds have a defined maturity date at which the principal is repaid. Maturities can range from short-term (1-5 years) to medium (5-10 years) to long-term (10+ years, even up to 30 years or more). In the capital market context, bonds are generally medium to long-term instruments.

Security & Risk

• Bonds can be secured or unsecured. A secured bond has specific assets pledged as collateral (for example, a bond might be secured by property, receivables, etc. of the issuer). Government bonds are typically unsecured but are backed by the government’s taxing power and hence considered very low risk (essentially risk-free in terms of default for central government bonds). Corporate bonds’ risk depends on the company’s creditworthiness – which is often assessed by credit rating agencies. Bonds are generally viewed as lower risk than equity in the same company, because bondholders have a higher priority claim on assets than shareholders and receive fixed interest, but they usually offer lower returns than equity as a trade-off for lower risk.
• Trading and Price: Bonds can be traded in the secondary market. Their prices can fluctuate based on interest rate changes and credit quality changes of the issuer. If market interest rates rise, existing bonds with lower coupon rates become less attractive, so their market price falls (and vice versa). Additionally, if an issuer’s credit rating improves, its bonds may rise in price (as default risk is lower); if credit worsens, bond prices fall.

Types of Bonds:

• Government Bonds: Issued by governments to finance fiscal deficits or projects. In India, central government bonds (also called G-secs) are generally long-term (5 to 40 years) and pay semi-annual interest. They are considered very safe. State governments issue bonds called State Development Loans (SDLs).
• Corporate Bonds: Issued by companies. These typically offer higher interest than government bonds to compensate for higher risk. They can be secured or unsecured.
• Zero-Coupon Bonds: These pay no periodic interest. Instead, they are issued at a discount to face value and redeemable at full face value at maturity. The difference is the investor’s return. For example, a zero-coupon bond might be issued at ₹5,000 and redeemed at ₹10,000 after 5 years – the ₹5,000 gain over 5 years is the implicit interest.
• Convertible Bonds: Corporate bonds that can be converted into a predetermined number of equity shares of the company, at the option of the bondholder (usually under specific conditions or periods). These typically have a lower coupon since they offer a potential upside from conversion into equity.
• Perpetual Bonds: Bonds with no fixed maturity date (often issued by banks or institutions as perpetual debt). They pay interest indefinitely until called or bought back by the issuer. In India, some banks issue perpetual bonds (also known as AT1 bonds) as part of their capital.
• Junk Bonds: A colloquial term for high-yield bonds, which are bonds rated below investment grade by credit rating agencies. They offer higher interest due to higher default risk (often issued by companies with weaker credit).

Debtholder’s Rights

Bondholders are creditors, not owners. They do not have ownership or voting rights in the issuer’s management. However, they have a contractual right to timely interest and principal repayment. If the issuer fails to pay (defaults), bondholders can take legal action and in bankruptcy, they will claim assets before shareholders.

Example: Suppose the Indian government issues a 10-year bond of ₹1,000 face value at 7% annual coupon. If you buy one bond, you will receive ₹70 per year for 10 years (interest), and at the end of 10 years, you get back ₹1,000 principal. If you need your money earlier, you can sell the bond in the secondary market at the prevailing market price, which might be above or below ₹1,000 depending on interest rates at that time.

Debentures

The term debenture in India typically refers to a type of debt instrument very similar to bonds. In many contexts, bonds and debentures are used interchangeably, but there are subtle distinctions and the usage can vary by country. Important points about debentures:

• Corporate Debt Instrument: Debentures usually refer to unsecured corporate bonds in traditional usage (especially in international contexts, a debenture often means a bond not backed by specific collateral, relying on the issuer’s general credit). However, Indian companies often issue debentures that can be secured or unsecured. For example, Non-Convertible Debentures (NCDs) issued by companies may be secured by assets or may be unsecured.
• Interest and Maturity: Like bonds, debentures carry a fixed coupon rate and have a maturity date. Investors in debentures receive periodic interest and get the principal back on maturity. If a debenture is convertible, it means it can be converted into equity shares of the company after a specified period or on certain terms (these are convertible debentures; if they are not convertible, they’re called NCDs).
• Issuance: Companies issue debentures as part of raising long-term debt. Debentures are often issued in series or tranches, and each debenture certificate acknowledges the debt. According to the Companies Act, a debenture is a written instrument acknowledging a debt, often under the company’s seal, promising to pay the specified sum (principal) and interest. Debenture certificates or deeds often contain the terms of repayment and interest.

Debenture vs Bond

In the Indian context, practically speaking, there’s a large overlap:

• Bonds might be used for debt securities issued by government or government-backed entities, and also by companies (especially when offered to the public or in international markets).
• Debentures generally refer to debt instruments issued by companies, typically in domestic markets. Many companies call their debt issues debentures.
• One distinction often cited: Debentures in India are frequently issued to the public via a prospectus or to institutions and may require a debenture trust deed and appointment of a Debenture Trustee (an entity that represents debenture holders’ interests and ensures the company fulfills its obligations). Bonds might sometimes be placed privately or be of specific types (like infrastructure bonds, tax-free bonds by PSUs, etc.).
• In terms of priority, both bondholders and debenture holders are creditors. If a debenture is unsecured, it ranks equal to other unsecured debt. If it’s secured by collateral, debenture holders have claim to those specific assets.

Regulation

Both bonds and debentures in India come under the purview of SEBI (if public issue) and are subject to guidelines such as SEBI’s Issue and Listing of Debt Securities regulations. Companies cannot term an instrument “debenture” if it’s essentially equity (to avoid confusion, compulsorily convertible debentures that convert to equity are treated as equity for many regulatory purposes).

Example of Debenture

A company, ABC Ltd., might issue “10% ABC Ltd. Secured NCDs, 2026” for ₹100 crores, meaning they offer debentures that pay 10% annual interest and will be repaid in 2026. If these are secured, ABC Ltd. would have pledged some assets or cash flows as security, and a debenture trustee will monitor that. Investors who buy these debentures will receive interest (often semi-annually 5%+5%) and principal in 2026. If ABC Ltd. fails to pay interest or principal, debenture holders (through the trustee) can enforce their claim on the pledged assets or take legal action.

Key Differences Between Shares and Debentures/Bonds

Understanding how shares differ from bonds/debentures is crucial:

• Ownership vs Loan: Shares signify ownership in a company (shareholders are owners/partners in the business). Bonds/Debentures signify a loan to the company (holders are creditors, not owners).
• Returns: Shareholders earn dividends (variable, not guaranteed) and capital gains if share prices rise. Bond/debenture holders earn fixed interest (coupon) which is contractual, and their principal is to be returned at maturity. They usually do not directly benefit from extra profits beyond their fixed interest.
• Risk and Priority: In case of liquidation or bankruptcy, bond/debenture holders are paid before shareholders. Debts must be cleared (to the extent possible) before any residual value is given to equity shareholders. Therefore, bonds/debentures are safer in terms of capital recovery, whereas shares are riskier (but have higher return potential). Also, interest on bonds must be paid as per schedule (else it’s a default), whereas dividends on shares can be skipped if the company chooses.
• Tenure: Equity shares are generally perpetual – they represent a continuing ownership (no maturity date; they exist as long as the company exists or until the shareholder sells in market). Bonds/debentures are for a fixed period (until maturity) after which they are redeemed. However, some bonds can be perpetual and some shares (preference shares) can be redeemable – those are exceptions.
• Control: Shareholders (particularly equity shareholders) have voting rights and thus a say in management (proportionate to shareholding). Bond and debenture holders do not have voting rights or a say in how the company is run (except in specific situations like restructuring discussions if the company is in financial distress).
• Issuer’s Perspective (Cost): Paying interest on bonds/debentures is an obligation and is usually tax-deductible expense for the company. Paying dividends on shares is not obligatory (they can skip in bad years) and not tax-deductible (dividends are distributed from profit after tax). Excessive debt (bonds/debentures) can strain a company’s finances due to fixed interest commitments, whereas equity can absorb losses (no fixed payout). But equity dilutes ownership and profits among more shareholders and may expect higher returns overall.

Shares vs Bonds/Debentures