Fixed income securities - Security Analysis and Investment Management

Preference shares:

Capital stock which provides a specific dividend that is paid before any dividends are paid to common stock holders, and which takes precedence over common stock in the event of liquidation. Like common stock, preference shares represent partial ownership in a company, although preferred stock shareholders do not enjoy any of the voting rights of common stock holders. Also unlike common stock, preference shares pay a fixed dividend that does not fluctuate, although the company does not have to pay this dividend if it lacks the financial ability to do so. The main benefit to owning preference shares are that the investor has a greater claim on the company assets than common stockholders. Preferred shareholders always receive their dividends first and, in the event the company goes bankrupt, preferred shareholders are paid off before common stockholders.

Debentures and bond:

A type of debt instrument that is not secured by physical asset or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond in order to secure capital. Like other types of bonds, debentures are documented in an indenture. Debentures have no collateral. Bond buyers generally purchase debentures based on the belief that the bond issuer is unlikely to default on the repayment. An example of a government debenture would be any government-issued Treasury bond (T-bond) or Treasury bill (T-bill). T-bonds and T-bills are generally considered risk free because governments, at worst, can print off more money or raise taxes to pay these type of debts Bonds and debentures are fixed income instruments which are taken by investors looking for regular, fixed income through payment of interest on the principal purchase. Bonds and debentures are debt instruments with different types of exposure. In general terms bondholders are secured by access to the underlying asset in case of default by the issuer. Debentures, on the other hand, are unsecured, and debenture holders do not have recourse to assets in the case of default by the debenture issuer.

Convertible debentures:

A type of loan issued by a company that can be converted into stock by the holder and, under certain circumstances, the issuer of the bond. By adding the convertibility option the issuer pays a lower interest rate on the loan compared to if there was no option to convert. These instruments are used by companies to obtain the capital they need to grow or maintain the business. Convertible debentures are different from convertible bonds because debentures are unsecured; in the event of bankruptcy the debentures would be paid after other fixed income holders. The convertible feature is factored into the calculation of the diluted per-share metrics as if the debentures had been converted. Therefore, a higher share count reduces metrics such as earnings per share, which is referred to as dilution.

Government securities:

A government bond is a bond issued by a national government, generally promising to pay a certain amount (the face value) on a certain date, as well as periodic interest payments. Bonds are debt investments whereby an investor loans a certain amount of money, for a certain amount of time, with a certain interest rate, to a company or country. Government bonds are usually denominated in the country's own currency. Bonds issued by national governments in foreign currencies are normally referred to as sovereign bonds, although the term "sovereign bond" may also refer to bonds issued in a country's own currency. The first ever government bond was issued by the English government in 1693 to raise money to fund a war against France. It was in the form of a tontine. Later, governments in Europe started issuing perpetual bonds (bonds with no maturity date) to fund wars and other government spending. The use of perpetual bonds ceased in the 20th century, and currently governments issue bonds of limited duration.

Government bonds are usually referred to as risk-free bonds, because the government can raise taxes or create additional currency in order to redeem the bond at maturity. Some counter examples do exist where a government has defaulted on its domestic currency debt, such as Russia in 1998 though this is very rare. Another example is Greece in 2011. Its bonds were considered very risky, in part because Greece did not have its own currency.

Public sector undertakings bonds:

Public Sector Undertakings (PSUs) issue debentures that are referred to as PSU bonds. Minimum maturity of PSU bonds is generally 5 years for taxable bonds and 7 years for tax-free bonds. The maturity of some bonds is also 10 years. The typical maturity of a corporate debenture is between 3-12 years. Debentures with lower maturity are normally issued as debenture convertible partly or fully into equity. The interest income from bonds and debentures is classified under the heading “income from business or profession”. The difference between face value and issue price in the case of Deep Discount Bonds can be classified as interest to be accrued on field basis every year. The incidence of TDS on bonds and debentures depend on the terms and structure thereof. The interest on taxable bonds is exempt only up to a certain limit as per section 80L of the Income-Tax Act, whereas the interest on tax-free bonds is fully exempt. While PSUs are free to set the interest rates on taxable bonds, they cannot offer more than a certain interest rate on tax-free bonds, which is fixed by the Ministry of Finance. More important, a PSU can issue tax-free bonds only with the prior approval of Ministry of Finance.

In general, PSU bonds have the following investor-friendly features-

  1. There is no deduction of tax at source on the interest paid on these bonds;
  2. They are transferable by mere endorsement and delivery;
  3. There is no stamp duty applicable on transfer; and
  4. They are traded on the stock exchanges.

In addition, some institutions are ready to buy and sell these bonds with a small price difference.

Kisan Vikas Patra (KVP): Kisan Vikas Patra (KVP) comes in the denominations (face value) of Rs. 1,000, Rs. 5,000 and Rs. 10,000. There is no maximum limit on the purchase of certificate. KVP double the money in 8.7 years that works out to a yield of a little over 8 per cent. As tax concessions are not available on interest amount, for investors in higher tax brackets, the yields are somewhat lower.

Investors can also use money in emergencies by breaking it after 2.5 years. However, early withdrawal lowers returns. Certificate can be encashed at the post-office of its issue.

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Security Analysis and Investment Management Topics