Real-World Market Exchange: Debt Tokenization Explained

In the conventional sense, bonds are debt instruments issued by entities, including companies and governments, with a promise to pay back the invested capital along with interest over a specific period. In South African law, bonds can be registered over movable and immovable assets, providing a form of security to the bondholders. These bonds may be secured through a mortgage bond over immovable property, or through notarial bonds, tying the company’s tangible assets to the financial instrument.

On the other hand, debentures are unsecured debt instruments that companies issue without offering any collateral. They can exist in various forms, including bearer debentures, which come with fixed or variable coupon rates, and profit-sharing debentures, providing a share in the company’s profits.

Debt instruments come in various forms, with their defining characteristics being the return they offer and the security they provide. Let’s delve into understanding these types, ensuring they are easily comprehensible even to those new to this financial world.

Profit-share and fixed coupon debentures are a unique form of unsecured debt where the return to the investor comes in two forms: a fixed percentage of the original investment (known as a coupon), and a share in the issuing company’s profits. This means that investors get a guaranteed return (the fixed coupon) plus a potentially variable additional return based on the company’s profitability.

Much like the debentures described above, profit-share and fixed coupon bonds offer a fixed return (the coupon) and a share in profits. The difference lies in the backing of these bonds. Bonds can be secured against the assets of the issuing company, which offers additional assurance to investors. If the company fails to meet its financial obligations, assets can be sold to repay bondholders.

Profit-share only bonds offer returns tied solely to the issuing company’s profits. These types of bonds are more variable in their returns as they depend entirely on the company’s financial performance. While this may seem riskier, the potential for higher returns when the company performs well can make these attractive for risk-tolerant investors.

Fixed coupon only bonds promise a fixed return to the bondholder, regardless of the company’s performance. The ‘coupon’ is a predetermined interest rate paid regularly until the bond’s maturity date. These are typically preferred by investors seeking stable, predictable income.

Variable coupon bonds are debt instruments that provide investors with a unique feature in their coupon payments. Unlike fixed coupon bonds, the interest rate on variable coupon bonds is not set at a fixed rate. Instead, the coupon payments fluctuate based on certain predetermined factors, such as prevailing market interest rates or the issuer’s financial performance. This flexibility allows investors to potentially benefit from changes in interest rates, as their coupon payments may increase or decrease accordingly. However, variable coupon bonds also introduce a level of uncertainty as investors face the possibility of receiving lower coupon payments if interest rates decline. Overall, variable coupon bonds can be an appealing option for investors seeking the potential for higher returns in a dynamic market environment.

Profit-share only debentures are unsecured debt instruments where returns are entirely based on the company’s profits. The potential for higher returns exists when the company does well, but the risk is higher compared to fixed return instruments. These are usually favoured by investors who are comfortable with higher risk for potentially higher returns.

Fixed coupon only debentures are unsecured debts that provide a fixed return to the investor. The company pays a set interest rate (coupon) regularly until the debenture’s maturity date. These debentures appeal to those seeking a stable return on their investment, without any link to the company’s profits.

Variable coupon debentures are unsecured debts that offer investors a unique feature in their coupon payments. Unlike fixed coupon debentures, the interest rate on variable coupon debentures is not set at a fixed rate. Instead, the coupon payments fluctuate based on certain predetermined factors, such as prevailing market interest rates or the company’s financial performance. This flexibility allows investors to potentially benefit from changes in interest rates, as their coupon payments may increase or decrease accordingly. However, variable coupon debentures also introduce a level of uncertainty as investors face the possibility of receiving lower coupon payments if interest rates decline. Overall, variable coupon debentures can be an appealing option for investors seeking the potential for higher returns in a dynamic market environment.

Capital Raising: An entity issues a flip debenture to investors to raise capital specifically for the acquisition of land or properties that are seen as having good potential for development and a subsequent increase in value.

Profit-Sharing Mechanism: The flip debenture has a built-in mechanism for profit-sharing, meaning that once the land or properties are sold, the profits are distributed to investors according to the terms agreed upon at issuance.

Development and Sale: The issuer utilizes the raised funds to develop the land or renovate the properties, aiming to enhance their market value. After development, the properties are sold at a profit, ideally in a short timeframe to align with the flipping strategy.

Risks and Rewards: The risk to investors is substantial because they rely entirely on the success of the property development and the market conditions at the time of sale. If the project does not yield a profit, or if the market conditions are unfavorable, investors may not see a return on their investment.

Investor Profile: This type of instrument would likely appeal to speculative investors who are willing to accept higher risks for the chance of a higher return, depending on the success of the flip.