Cost of Capital^45
payments but in debt securities it is usually a lump sum payment at the end of the period
(or a series of payments).
Terms Associated with Debt Securities
There are several terms which are used when we talk about debt securities. Before
we take a look at different kinds of debt securities available in the Indian market, let us
first understand these terms.
Face Value/ Par Value
Value of the security as mentioned on the certificate of the security. Face values and
par values are two terms which are used interchangeably. Corporate debentures are
usually issued with Rs.100 face values and Government bonds with Rs.1 lac face
values. Although the value of the debenture (or the Government bond) will fluctuate in
price from the time they are issued until redemption, they are usually redeemed at
maturity at their face value (unless a premium is to be given on redemption).
The face value is the amount on which the interest is calculated. Thus, a 15 per cent
debenture with a face value of Rs.100 will pay debenture holders Rs.15 per debenture
per year.
Coupon Rate
The coupon rate is the stipulated interest rate to be paid on the face value of a bond. It
represents a fixed rupee amount that is paid periodically as long as the debtor is solvent.
The period could be monthly, quarterly, semi-annually or annually. Zero-coupon bonds
(discussed later) are also common. The coupon rate could be a fixed rate or a floating
rate. The floating rate is normally pegged to a base rate (e.g. 1 per cent above bank
rate) and fluctuates with the fluctuation in the base rate. The coupon rate is fixed after
the issuing corporation's merchant banker has weighed the risk of default, the credit
rating of the issuer, options attached with the issue, the investment position of the industry,
the security backing of the debenture, and the appropriate market rate of interest for
the firm's industry, size, and risk class. The goal is to pick a coupon rate that is just high
enough to attract investors.
Interest payments
Debenture interest is usually paid semi-annually, though annual payments are not
uncommon. In India we normally have registered debentures on which the interest is
payable to the debenture holder whose name appears on the register when the payment
is made. In developed countries, coupon bonds are also available which have a series
of attached coupons that are clipped off at the appropriate times and sent to a bank for
collection of the interest. Of course, now with the Electronic Clearing System, the
interest can be directly deposited in the bank account of the bond holder.