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Securities with maturity period more than a year are known as long-term financial instruments.
There are three main long-term financial instruments; they are:
Common stocks (equity shares or ordinary shares)
Debt capital (bonds, debentures or long-term loan)
Preference stocks (preference shares)
Here, debt means long-term debt.
Debts capital means loan capital collected or raised by debenture, corporate bonds, long-term bank loan etc.
A limited company collects beginning capital from equity shares capital then it can collect capital from debt.
The company may require additional money for its expansion, growth, diversification and modernization.
For this purpose, the company can borrow debt capital from public.
Debentures or bonds are medium term or long-term loan from public.
Keep in Mind (KIM)
Short-term upto one year |
Long-term more than one year |
Medium term five to ten years |
Very long-term more than ten years |
Debentures are issued by a limited company to raise medium term loan.
Amount of debenture can be used for expenses or future expansions of the business.
Debentures can be transferred to anyone.
The owners of debentures are called debenture holders.
Debenture holders do not have voting right in the company’s general meetings.
Debentures are simply loans taken by the companies and they do not provide the ownership in the company.
These are unsecured loans.
The company is not bound to return the principal amount on the maturity.
There are different types of debentures.
Out of them, mainly there are two types of debentures.
They are convertible and non-convertible.
The convertible debentures can be converted into new debentures, equity share or preference shares.
Non-convertible debentures do not convert into equity shares and other types of debentures.
Thus, these debentures can yield a higher interest rate
When limited company issues bonds, they are known corporate bonds.
The government also issues bonds.
They are known government bonds or municipality bonds.
Bonds are secured with the fixed assets of the company.
These bonds are issued by the companies for meeting expenses and future expansions.
The borrower pays interest at regular intervals.
The principal amount will be returned on maturity.
It is known redemption of bonds.
Both bonds and debentures are long-term loan instruments.
They are issued to raise capital from the public.
They have some similarities but following are main differences:
Bases |
Bonds |
Debentures |
Security |
Bonds are more secured than debentures when they are issued by government. |
Debentures are less secured than bonds. |
Interest rate |
Bonds carry low interest rate than debentures. |
Debentures carry high interest rate than bonds. |
Periodical interest |
Bond holders do not receive periodical payments of interest. |
Debenture holders get periodical interest. |
Insolvency |
If there is any insolvency, bondholders are paid first. |
If there is any insolvency, debenture holders are paid after bondholders. |
Definition
“Debentures are a debt or loan raised by a company under the seal of the company.”
According to Company Act, “A trustee is necessary to raise or issue debentures or debt capital.”
Keep in Mind (KIM)
There are different types of bonds; they are: |
Treasury bond: it is issued by central bank. |
Corporate bond: it is issued by corporate bank or corporate company. |
Municipal bond: it is issued by state government. |
Foreign bond: it is issued by foreign company (invested in foreign company). |
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Accounting Equation |
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Basic Journal Entries in Nepali |
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Basic Journal Entries |
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Journal Entry and Ledger |
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Ledger |
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Subsidiary Book |
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Cash Book |
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Trial Balance & Adjusted Trial Balance |
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Bank Reconciliation Statement (BRS) |
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Depreciation |
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Final Account: Class 11 |
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Adjustment In Final Account |
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Capital and Revenue |
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Single Entry System |
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Non-Profit Organization (Non-Trading Concern) |
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Government Accounting |
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Goswara Voucher (Journal Voucher) |
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Features of Debentures or Corporate Bond
The company that issues debentures is known borrower.
The person or company who purchases debenture is known lender or subscriber.
Principal is the value of the debenture. It is also called the par value or face value of the debenture.
In Nepal, generally face value of one debenture is Rs 1,000.
Debentures can be issued at par, at discount or at premium
Coupon rate means interest rate of debenture.
Interest rate of debenture is prefixed. It is paid always on face value.
It is payable annually, half yearly or quarterly
It is the date on which the borrower has agreed to repay the principal amount to lender.
Term-to-maturity refers to the number of years remaining for the debenture to mature.
The term-to-maturity changes every day from date of issue of the debenture until its maturity.
Convertible bonds or debentures are converted into new type of bonds, equity or preference shares.
This conversation may be at par, discount or premium.
Collateral is the property pledged to get loan by corporations from general public or business enterprises.
While issuing bonds collateral is essential.
Keep in Mind (KIM)
The coupon is the product of the principal and the coupon rate. |
Limited company issues debentures. |
State or central government issued bonds. |
Maturity period is also called tenure of the debenture or bond. |
For example
CG2018; 11% bonds refer to a Central Government bond maturing in the year 2018 and paying a coupon of 11%. Central Government bonds have a face value of Rs 1,000 and normally pay coupon semi-annually, this bond will pay Rs 55 as six-monthly coupon, until maturity.
The types of debentures are given below:
1. |
On the basis of record: |
(a) Registered |
(b) Bearer |
2. |
On the basis of redemption: |
(a) Redeemable |
(b) Irredeemable |
3. |
On the basis of convertible: |
(a) Convertible |
(b) Non-convertible |
4. |
On the basis of security: |
(a) Secured |
(b) Un-secured |
5. |
On the basis of priority: |
(a) First |
(b) Second |
6. |
On the basis of enforcement: |
(a) Collateral security |
The debenture that cannot be transferred to another person is known registered debentures.
The person who has such debentures, his name and address is registered with the company.
He has right to get interest and principal amount of these debentures.
This is also known unregistered or coupon debentures.
The person who has such debentures, he is the owner of debentures.
He has right to get interest and principal amount of these debentures.
These type debentures can be redeemed or repaid after its maturity period.
The company is bound to pay the principal amount of debentures to debenture holders within specified time.
These type debentures cannot be redeemed or repaid during the life of the company.
This is also called perpetual debenture. Interest is paid every year.
The principal amount is paid only at the time of winding-up the company.
These types debenture holders have right to convert their debentures into new debentures, equity shares or preference shares.
Conversion may be at par, discount or premium.
These types debenture holders has not right to convert their debentures into new debentures, equity shares or preference shares.
This is also called mortgage debentures.
To issue these debentures, fixed assets deposit as security.
If the company cannot repay principal amount, debenture holders can realize their amount by selling fixed assets.
This is also called naked or simple debentures.
These typed of debenture holders are not given any security for issuing debentures.
They are only creditors of the company.
These types of debenture holders have authority to claim on the assets of the company.
They have priority to repayment of principle amount before other debenture holders.
These types’ debenture holders can claim on assets after first debenture holders.
These debentures are issued against specific assets already used as security.
These debentures are issued to take loan from bank or financial institute.
Generally, values of debentures are more than loan.
But interest is calculated on loan not on deposited debentures.
If the company cannot pay its loan and interest within time, bank or financial institute automatically becomes debenture holders and the company has to pay more interest.
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Share (Accounting for Share) |
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Share in Nepali |
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Debentures |
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Final Account: Class 12 |
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Final Account in Nepali |
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Work Sheet |
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Ratio Analysis (Accounting Ratio) |
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Fund Flow Statement |
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Cash Flow Statement |
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Theory Accounting Xii |
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Theory: Cost Accounting |
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Cost Accounting |
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LIFO−FIFO |
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Cost Sheet, Unit Costing |
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Cost Reconciliation Statement |
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There are various types of bonds in the financial market; some of them are summarized below:
The long-term debts secured by the collateral of specific fixed assets are known as mortgage bonds.
Generally, fixed assets are land and building, machinery and equipment.
If the company is unable to pay the principal of the bond, the bondholders can take their money by selling fixed assets.
Debenture is an unsecured bond issued by a company without pledging any specific assets as collateral.
The use of debenture depends on the nature of asset of the firm and general credit strength.
Therefore, debenture holders are general creditors of the firm.
The bond which can be converted into equity share is called convertible bond.
Convertible bond also may be converted into new types bonds and preference share.
Conversion depends on the desire of the bondholders.
Such rights are specified in the indenture.
This conversion may be at par, discount or premium.
If company can call bond holders for redemption before maturity, it is known callable bond.
When the company thinks that interest rates will fall in the near future, it may call the bond.
After paying off the principal amount of bonds, the company issues new bonds at the lower interest rate.
It is a type of bond in which return is given according to income level of the company.
Some income bonds have cumulative interest in feature.
It means unpaid interest of preceding years is paid when the company will have sufficient earnings.
These types of bonds are not in the Nepalese market.
The bonds, which have no coupon rate and sold at a discount basis is called zero coupon bond.
This bond is also called pure discount bond.
The investors receive attractive returns from the difference between issue price (sold price) and par value.
Companies prefer to issue zero coupon bonds when their cash flows are not regular.
A junk bond has a relatively high risk of default.
Junk bonds are riskier than most other types of bonds. Junk bond pays high interest rate.
Therefore, this bond is also known as a high yield bond or speculative bond.
Normally, these bonds are issued by those companies whose financial strength is not so good.
When interest rates of the bonds are fluctuating due to inflation, it is known floating rate bonds.
Generally, interest rate is adjusted every six months based on market interest rate.
Company can issue floating rate bonds instead of issuing fixed interest rate.
In instable interest rate environment, company uses floating rate bonds to reduce risk.
The main advantages of corporate bond are as follows:
(A) From the view point of company (issuer)
While comparing with the equity shares, issue of debts is less costly.
On equity share, company has to pay dividend upto life time of the company but debt is callable or redeemable.
Therefore, it is less risky investment.
Interest paid to the bondholders is a tax deductible expense.
It reduces the tax liabilities of the company.
Deducted tax must be deposited to state or central government.
In other words, while paying interest on debts, tax should be deducted.
The corporation can bring flexibility in its capital structure by issuing bonds because the call provision can be kept in bond indenture.
Some loans can be repaid before maturity.
The cost of the loan is definitely limited. When the company earns high profit, the bond holders cannot receive additional interest.
Therefore, the bond holders receive only definite income whereas; the ordinary shareholders receive more income.
(B) From the view point of investors
The bonds are low risky to the investors because most of the bonds are secured with the fixed assets.
Secured bonds are safe investment for the investors.
There is fixed interest rate on the bond, except in income bond.
Therefore, the investors receive fixed regular income from bonds.
Some bonds are convertible.
In such situation, the bondholders can convert their bonds into common stocks, new bonds or preferred stocks.
The bonds are more marketable than shares.
Bonds can be sold easily in the share market.
Thus, the investors are able to get higher liquidity.
The main disadvantages of long term debt are as follows:
(A) From the view point of company (issuer)
Long-term debts increase the financial leverage of the company.
It may be unfavourable to those companies which have fluctuating sales and earnings.
Bondholder can take the company into liquidation if they do not get regular interest and principal at maturity.
There is a limit to raise fund through the long-term debt. Standard equity and loan ratio is 3:2.
According to the financial policy, the loan ratio should not cross the limit.
If loan is taken more than this limit, the cost of the loan increases.
Generally, long-term debt has a fixed maturity period.
The debt must be repaid on that period.
It needs sufficient cash outflows.
Large amount of cash outflow will negatively affect financial position of the company.
(B) From the view point of investors
Long-term debts contain fixed interest rate.
The debt holders will not receive extra profit.
They receive limited income as interest even the company earns large profit.
Therefore, their income is limited.
The debt holders do not have voting rights in the affairs of the company.
They cannot elect the board of directors.
As compared to preferred stock and common stock, the bond or debt has the lower rate of return.
The debt holders will not receive extra interest even the company earns large profit.
Keep in Mind (KIM)
In India, there are four types of bonds: Government bonds; Corporate bonds; Financial institutions bonds; Tax saving bonds. |
Siddhartha Bank Limited has issued debenture in Nepal Main features are as follows: Maturity period: 7 Years. Interest rate: 8.5% per annum. Interest payment frequency: Half yearly. Claim in case of liquidation: After depositors. Debenture redemption reserve shall be created to redeem the bond at maturity. The debenture can be pledged with other banks and financial institution. The Siddhartha bank limited debenture 2072 has been listed on Nepal stock exchange from 23 Ashadh 2067 (2010 July 7 Wednesday) while the trading of the debentures was started from 30 Ashadh 2067 (2010 July 14 Wednesday). There are total 227,770 units of debenture of Rs 1,000 each. |
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