Certainly, bonds and debentures are the two classical options for investment that appeal to a risk-averse investor looking for a fixed income. Though both alternatives promise more or less constant returns, they differ in several respects. Learning about these differences will give investors an idea of how their investments would apply to their specific financial objectives and situations.
What are Government Bonds?
Government bonds are types of debt securities that are issued by the government to raise capital. When you buy a government bond, you are lending money to the government, which, in turn, pays you interest on the bond during its term and pays back the face value of the bond upon maturity.
They are regarded as having very low risks because they are backed by the government. For this reason, they attract conservative investors seeking stability and safety. Different countries can issue such bonds for various periods, spanning from several months to many decades.
What are Debenture Bonds?
A debenture bond (in short debenture) is a type of debt instrument corporations or companies issue, and one with which government bonds cannot compare.
A debenture bond, then, would be a loan from an investor to a corporation for which interest would be paid to the investor periodically with a contractual commitment that the principal will be paid back at a later date.
Debentures are not secured; that is, they are not secured by any tangible asset or property as collateral.
Simply, they rely on the creditworthiness and reputational standing of the issuing institution. This lack of security increases debentures’ risk factor as compared to government bonds that are backed by the whole faith and credit of the government.
What are Capital Gain Bonds?
Capital gain bonds refer to a specialized category of bonds designed to provide relief from tax liability for long-term capital gains. Long-term capital gains arise when an investor sells some asset such as real estate or from an investment in which capital gain had accrued.
The government, under some circumstances, allows taxpayers to invest in these bonds to defer or avoid the payment of capital gains tax.
A capital gain bond usually refers to bonds issued by the government or government-backed entities that give investors an option to claim exemptions against long-term capital gains. Within India, perhaps the commonest form of capital gain bond is the Rural Development Bond (under Section 54EC of the Income Tax Act).
Through an investment in these bonds, investors unwind the accrual of taxes of capital gains arising from the sale of property or land, thereby presenting a neat tax-saving opportunity.
Key Differences Between Government Bonds, Debenture Bonds, and Capital Gain Bonds
Issuer:
Government bonds are issued by the government.
Debenture bonds are issued by private companies or corporations.
Capital gain bonds are issued by government-backed entities or public sector companies for tax-saving purposes.
Risk:
Government bonds are low-risk, backed by the government’s guarantee.
Debenture bonds carry higher risk because they are unsecured and dependent on the issuing company’s financial health.
Capital gain bonds are typically low-risk because they are backed by the government or government entities.
Interest Rates:
Government bonds offer lower interest rates due to their lower risk.
Debenture bonds offer higher interest rates to compensate for the higher risk.
Capital gain bonds often offer lower returns, as their primary benefit is tax savings.
Purpose:
Government bonds are issued to raise funds for government projects and development.
Debenture bonds are issued by companies to finance their operations and expansion.
Capital gain bonds are specifically designed to help investors save on taxes from long-term capital gains.
Liquidity:
Government bonds are generally more liquid, meaning they can be easily sold in the secondary market.
Debenture bonds may have less liquidity depending on the issuing company’s market reputation.
Capital gain bonds are not typically sold in the secondary market and are meant to be held until maturity.
Conclusion
While government bonds and debenture bonds are both fixed-income securities, the key difference lies in the issuer and associated risk. Government bonds are low-risk, stable investments, while debentures offer higher returns but come with greater risks. Capital gain bonds serve a specific purpose for tax-saving, offering a lower return in exchange for tax advantages.
