Debt instruments like bonds, debentures, and commercial papers are crucial for businesses seeking capital and for investors looking for stable returns. Each serves a different purpose and carries unique features, risks, and tax implications. This guide explains these instruments in detail, helping you understand their structures and choose wisely.
A bond is a fixed-income security issued by governments, corporations, or institutions to raise funds. When you buy a bond, you lend money to the issuer in exchange for regular interest payments and the return of principal at maturity.
Bonds vary by issuer, structure, and purpose. Common types of bonds include:
A debenture is also a debt instrument issued by companies to raise capital but is typically unsecured, relying on the issuer’s creditworthiness rather than collateral. For example, a company might issue 10-year debentures at a fixed interest rate to finance a new plant.
A commercial paper (CP) is a short-term, unsecured debt instrument used by corporations to meet working capital needs. In India, CPs are usually issued at a discount and redeemed at face value.
It is a money-market instrument with maturities ranging from 7 days to 1 year, regulated by the Reserve Bank of India (RBI). Corporations with strong credit ratings typically issue CPs to fund short-term obligations.
Issuers: Corporates, primary dealers, and financial institutions.
Investors: Banks, mutual funds, insurance companies, and high-net-worth individuals.
Understanding the difference between bonds and debentures, and how commercial papers fit in, helps investors and businesses select the right instrument.
Feature | Bonds | Debentures | Commercial Papers |
---|---|---|---|
Nature | Secured (often) debt instruments | Usually unsecured corporate debt | Unsecured short-term debt |
Tenure | Medium to long-term (1–30 years) | Medium to long-term (1–10 years) | Short-term (7 days to 1 year) |
Risk Level | Low to moderate | Moderate to high (if unsecured) | Moderate (depends on issuer rating) |
Return | Fixed interest (coupon) | Fixed or floating interest | Discounted issue, redeemed at face value |
Marketability | Traded in bond markets | Traded on stock exchanges (NCDs) | Issued in money market, limited secondary trade |
Bonds, debentures, and commercial papers each play a vital role in financial markets. Bonds offer steady income and lower risk, debentures provide higher yields with varying security, and commercial papers meet short-term financing needs. Understanding their features, risks, and tax implications empowers both investors and businesses to make informed decisions.
Bonds are often secured by assets and issued by governments or corporations, while debentures are usually unsecured and depend on the issuer’s creditworthiness.
They can be relatively safe if issued by highly rated companies, but they carry credit risk since they are unsecured.
Corporates, primary dealers, and financial institutions with a good credit rating can issue commercial papers.
Bonds are generally safer, while debentures may offer higher returns but carry more risk.
Interest or discount income is taxed as per individual income tax slabs, and capital gains taxes apply on sale before maturity.