What are debt market instruments?

Debt instruments typically have maturities of more than one year. The main types are government securities called G-secs or Gilts. Like T-bills, Gilts are issued by RBI on behalf of the Government. These instruments form a part of the borrowing program approved by Parliament in the Finance Bill each year (Union Budget). Typically, they have a maturity ranging from 1 year to 20 years. Like T-Bills, Gilts are issued through auctions but RBI can sell/buy securities in its Open Market Operations (OMO). OMOs cover repos as well and are used by RBI to manipulate short-term liquidity and thereby the interest rates to desired levels. The other types of government securities include Inflation-linked bonds, Zero-coupon bonds, State government securities (state loans).
Types of Debt Instruments The various instruments of debt can be classified into long term and short term debt depending on the tenure for which the amount has been raised or the period of repayment. The various instruments under each category are mentioned below.

Debt Instruments

Characteristics of debt instruments The main characteristics of a debt instrument is as follows: Ease of Issue

Any company with or without prior track record can issue debt instruments. Fixed or floating rate of interest

These instruments can be floated with fixed or floating rate of interest and for any tenure. Impose fixed commitments on servicing

While being flexible in the nature of interest and tenure at the time of issue, these instruments impose fixed commitments on the business. In other words, irrespective of the performance of the business, servicing of such instruments in the form of interest and principal repayments would have to be made. Failure to do so would be termed as default with severely adverse impact on the companys standing in the financial community. Low risk, return characteristics

Investors in such instruments being creditors of the company have priority over equity and preference shareholders in receiving return (in the form of interest) in such instruments. Carries priority claim on the assets of the firm (if secured) in the event of bankruptcy. Bonds and Debentures Debt instruments can be further classified into the following categories based on the different characteristics with which they are floated in the market:

Debentures Bonds

Debentures Main characteristics

They are fixed interest debt instruments with varying period of maturity. Can either be placed privately or offered for subscription. May or may not be listed on the stock exchange. If listed on the stock exchanges, they should be rated prior to the listing by any of the credit rating agencies designated by SEBI. When offered for subscription a debenture redemption reserve has to be maintained. The period of maturity normally varies from 3 to 10 years and may also be more for projects with a high gestation period.

Bonds may be of many types - they may be regular income, infrastructure, tax saving or deep discount bonds. These are financial instruments with a fixed coupon rate and a definite period after which these are redeemed. The fundamental difference between debentures and bonds is that the former is normally secured whereas the latter is not. Hence in general bonds are issued at a higher interest rate than debentures. This avenue of financing is mainly availed by highly reputed corporate concerns and financial institutions. The three main kinds of instruments in this category are as follows:

Fixed rate Floating rate Discount bonds

The bonds may also be regular income with the coupons being paid at fixed intervals or cumulative in which the interest is paid on redemption. Unlike debentures, bonds can be floated with a fixed interest or floating interest rate. They can also be floated without interest and are called discount bonds as they are issued at a discount to the face value and an investor is paid the face value on redemption.and if offered for longer terms are known as deep discount bonds. The main advantage with interest bearing bonds is the floating interest rate, which is stipulated based on certain mark-up over stock market index or some such index. From the point of view of the investor bonds are instruments carrying higher risk and higher returns as compared to debentures. This has to be kept in mind while floating bond issues for financing purposes. With the current buoyancy in capital markets for equity instruments the demand for corporate bonds is low.

Types of debentures There are different kinds of debentures, which can be offered. They are as follows: Non convertible debentures (NCD) Partially convertible debentures (PCD) Fully convertible debentures (FCD)

The difference in the above instruments is regarding the redeemability of the instrument: In case of NCDs, the total amount of the instrument is redeemed by the issuer, In case of PCDs, part of the instrument is redeemed and part of it is converted into equity,

In case of FCDs, the whole value of the instrument is converted into equity. The conversion price is stated when the instrument is issued. The price of each equity share received by way of converting the face value of the convertible security i.e. debenture is called the conversion price. The number of equity shares exchangeable per unit of the convertible security i.e. debentures is called the conversion ratio. The period of time after which the debenture is converted into equity is called the conversion period. The convertible instruments are generally used to stem the sudden outflow of the capital at the time of maturity of the instrument causing temporary liquidity problems. Alternately, the company has to raise funds from a different source or issue fresh instruments to tide over and also has to bear the transaction costs in the process. Debentures might be either callable or puttable

Callable debenture is a debenture in which the issuing company has the option of redeeming the security before the specified redemption date at a pre-determined price. Similarly, a puttable security is a security where the holder of the instrument has the option of getting it redeemed before maturity.