I. PUBLIC SECTOR BONDS

What are bonds ?
 
Bonds are debt instru­ments in which the issuer promises a fixed rate of return (inter­est) to the holder and repay the prin­ci­pal after a cer­tain period of time.

It is a for­mal con­tract between the investor and the borrower stating that the borrower will repay the borrowed money with inter­est to the investor.

Bonds are issued by a com­pany, finan­cial insti­tu­tion or gov­ern­ment. Based on the matu­rity period, bonds can be divided into short term bonds and long term bonds.

Few ter­mi­nolo­gies of a bond

1)   Issuer    – Issuer of a bond is the bor­rower of cap­i­tal or the debtor.

2)   Holder   – Holder of a bond is the cred­i­tor of cap­i­tal or the lender

3)   Coupon – It is the inter­est rate on the bond

4)   Matu­rity – It is the date on which the issuer pays the principled amount 
       to the holder.

5)   Tenor    -- The period start­ing from the date of issue of bond till the date of 
       maturity of the bond is called tenor.

6)   Yield     – It is the total returns on invest­ment in bonds.

Investment in Bonds :- 

In the Indian mar­ket, Banks are the largest investors in bonds. Apart from bank, mutual funds, for­eign insti­tu­tional investors, Prov­i­dent funds also invest in bonds. In the year 2002, RBI 
cat­e­go­rized indi­vid­u­als as retail investors and allowed them to par­tic­i­pate in the auction car­ried by RBI. The min­i­mum bid has to be for an amount of Rs 10,000 and a sin­gle bid should not exceed Rs 1 Crore.

A) Public Sector Bonds, 

These bonds are medium and long term obligations issued by public sector companies where the Government shareholding is 51% and more.

Most of PSU bonds are in form of promissory notes transferable by endorsement and delivery.

No stamp duty or transfer deed is required at the time of transfer of bonds transferable by endorsement.

Government securities, Government guaranteed stocks and local Government stocks are often referred to as gilt-edged securities because they have been regarded as absolutely safe, although medium-term and long-term loans suffer from the effects of inflation much more than equity shares.

B) Finance Company’s Bonds,

Companies issue bonds to finance operations. Most companies can borrow from banks, but view direct borrowing from a bank as more restrictive and expensive than selling debt on the open market through a bond issue.

The costs involved in borrowing money directly from a bank are prohibitive to a number of companies.

In the world of corporate finance, many chief financial officers (CFOs) view banks as lenders of last resort because of the restrictive debt covenants that banks place on direct corporate loans. 

Covenants are rules placed on debt that are designed to stabilize corporate performance and reduce the risk to which a bank is exposed when it gives a large loan to a company.

In other words, restrictive covenants protect the bank's interests; they're written by securities lawyers and are based on what analysts have determined to be risks to that company's performance.

Here are a few examples of the restrictive covenants faced by companies:  

they can't issue any more debt until the bank loan is completely paid off; 

they can't participate in any share offerings until the bank loan is paid off;                                                                                                            

they can't acquire any companies until the bank loan is paid off, and so on.

Relatively speaking, these are straightforward, unrestrictive covenants that may be placed on corporate borrowing. However, debt covenants are often much more convoluted and carefully tailored to fit the borrower's business risks.

Some of the more restrictive covenants may state that the interest rate on the debt increases substantially should the chief executive officer (CEO) quit, or should earnings per share drop in a given time period. 

Covenants are a way for banks to mitigate the risk of holding debt, but for borrowing companies they are seen as an increased risk.

Simply put, banks place greater restrictions on what a company can do with a loan and are more concerned about debt repayment than bondholders.

Bond markets tend to be more forgiving than banks and are often seen as being easier to deal with. As a result, companies are more likely to finance operations by issuing bonds than by borrowing from a bank. 

N.B :-

Covenants  - a formal agreement , especially a written contract by  

                       which you agree to make regular payments to a

                       charity

Convoluted - folded or twisted in a complex way