Bonds vs Shares, Debt vs Equity,Gilt Edged securities: Meaning, Explained

suppose i want to start a factory. what i need for same?
land, labour and loads of money.......
now how can i arrange the money?
Now, There are two ways to arrange money for starting a company or to expand a company. First is Debt and Second Equity.

DEBT- BOND

as the word suggests it is borrowed money. one can borrow money from bank, friends, relatives...

• I write on a piece of paper: “To whoever pays me Rs.1000, I’ll pay annual 10% interest rate (Rs.100). And after 5 years, I’ll also repay the principle amount Rs.1000. No “ifs” and “buts”.
• This is one type of security paper. We call it “BOND”.
• IF you hold my bonds, I’m liable to pay you money no matter what happens. Whether my company actually makes profit or not. I have to keep paying fixed money to you, every year. 

• there are credit rating companies like CRISIL, S&P, Moody’s etc. They’ll give credit ratings to a bond. (i.e. Am I capable enough to actually pay you?).
• Based on that, they give ratings example AA,A, BBB, BB,C,D etc.

 what are junk bonds?????

if bonds have rating below C  OR  D then it will not attract buyers. so in this case issuer will attract buyers by giving high rate of interest say 25%...
that why it is also called as “High Yield Bond”, because you’re getting higher profit.

what  is Gilt edged security?

• Government also needs finance- at times when tax collection is low and they need some temporary funds.
• They issues treasury bonds. RBI sells these treasury bonds on Government’s behalf.
• Government bonds have higher credit ratings (AA). So, they don’t need to seduce you, they’ll offer very low rate, say 4%.
• Similarly, well known companies with high credit ratings (AA) also issue bonds but pay low  rates.
• If you don’t like to take risks, you’ll invest in such bonds. These are called ‘gilt-edged securities’.

what is a bearer bond?

Bearer bonds are same as regular bonds, but they don’t have “Holder’s Name” on them. These bearer bonds have coupons attached with them. So, if you don’t want to withdraw the whole money, you can cut a few coupons and sell them to a broker to withdraw partial amount.

No one can keep a track of who withdrew the money, who’s buying, who’s selling Because there are no “names”, addresses or records. Although, in real life, it is hard to find Bearer bonds. Because most of the bonds now, exist in Electronic (DEMAT) format and you’ve to give your pan card number (or other similar personal information in foreign countries) to buy or sell  bonds/shares or any similar security papers.

okay enough about borrowing money. lets talk about giving a partenership ( EQUITY)...

EQUITY- I take money from you and in return I offer you partnership. This is called Equity.

• Assuming that I need 1 crore rupees to start my company and I’ve 30 lakhs in my savings. So, I write on a piece of paper: “ I’ll give 0.0001% ownership of my company to whoever gives me Rs.1000”.
• This is again a type of ‘security-paper’. But since I’m sharing a part of ownership with you, in crude terms, we’ll call it “Share”.
• Then I print 10,000 such papers. What’s the value of these papers?
• And since I already have Rs.30 lakhs, I can purchase 3000 shares. (because 3000 papers x Rs. 1000 each = 30 lakhs)
• So out of the Total 10,000 shares that I printed, I will own 3,000 shares, so percentage wise I own 30% of this company’s equity.

Debt vs Equity : good and Bad things

• In real life, companies don’t rely on single source to finance their adventure. They’ll arrange part of the cash from Debt (Borrowing) and part of the cash by issuing IPOs (Equity).
• Each has its own advantage and disadvantage. Let’s check

Good things: bonds vs shares

Debt (Bond)	Equity (IPO/Shares)
I have complete ownership and control over the company. I’m accountable to no body. I don’t have to ‘share’ my profit with anyone. I can claim income tax deduction for paying the loan. It require less paperwork and time to borrow from bank / friend than via sharemarket (SEBI permission, board of directors etc)	If the company makes loss, I don’t have to share any money with the shareholder, just like Kingfisher. So there is no ‘regular’ interest payment, as we do in the loan. Meaning I’ve less tension compared to bank loan/ bonds.

Bad things: bonds vs shares

Debt (Bond)	Equity (IPO/Shares)
Even if I don’t make profit, I’ve to pay interest rate, because basically this is a ‘loan’ just like home loan or car loan. Whether you earn or not, you’ve to pay the EMI. I may have to mortgage something (machinery, building) to get the loan. So in case I default on the loan, the bank/financer can take it away from me.	I don’t get complete ownership and control over the company. I’ve to constitute a board of directors, hold general meetings of shareholders, I’m accountable to them. The board of directors can throw me out of CEO job, if I donot deliver results. It requires heavy paperwork and time to initiate IPO, sharemarket thing (SEBI permission, underwriting etc)

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