A debenture is a type of debt instrument that companies issue to raise capital for their operations. In simple words, debenture is a written acknowledgement of debt. Debentures are a popular way for companies to raise money from investors without diluting ownership. In this article, we will discuss what is debenture, its meaning, types and everything you need to know about it.
What is a Debenture?
A debenture is a long-term debt instrument that is issued by companies to borrow money from the public. It is a promise by the issuer to pay the principal amount at a specified date along with interest on it. Debentures are not secured by any collateral or assets of the company, but the issuer’s creditworthiness guarantees the payment of the principal and interest. The interest on debentures is paid periodically, usually semi-annually or annually.
Types of Debentures:
Convertible Debentures:
Convertible debentures are those debentures that can be converted into equity shares of the issuing company at a predetermined price and date. Convertible debentures offer the holder the flexibility to convert the debt into equity, depending on the performance of the company.
Non-Convertible Debentures:
Non-convertible debentures are those debentures that cannot be converted into equity shares of the issuing company. These are the most common types of debentures, and they offer a fixed rate of interest to the holder.
Fully Convertible Debentures:
Fully convertible debentures are those debentures that can be converted into equity shares of the issuing company at a predetermined price and date. The only difference between convertible debentures and fully convertible debentures is that fully convertible debentures can be converted into equity shares at any time.
Partly Convertible Debentures:
Partly convertible debentures are those debentures that can be converted into equity shares of the issuing company at a predetermined price and date, but only a portion of the debentures can be converted. The remaining portion of the debentures continues to earn a fixed rate of interest.
Secured Debentures:
Secured debentures are those debentures that are secured by the assets of the issuing company. In case of default, the holder of the secured debenture has the right to take possession of the assets pledged as collateral.
Unsecured Debentures:
Unsecured debentures are those debentures that are not secured by any assets of the issuing company. In case of default, the holder of the unsecured debenture has to rely on the creditworthiness of the issuing company.
Redeemable Debentures:
Redeemable debentures are those debentures that can be redeemed by the issuing company at a specified date or after a specified period. The holder of the debenture receives the principal amount along with the interest earned.
Irredeemable Debentures:
Irredeemable debentures are those debentures that do not have a maturity date. The issuer has to pay interest on the debenture until the holder decides to sell it in the secondary market.
Advantages of Debentures:
- Lower Cost of Capital:
Debentures have a lower cost of capital as compared to equity. The interest paid on debentures is tax-deductible, which reduces the cost of debt.
- No Dilution of Ownership:
Debentures do not dilute the ownership of the issuing company. The holder of the debenture does not have any voting rights and is not entitled to participate in the management of the company.
- Easy Availability:
Debentures are easily available in the market, and investors can invest in them according to their risk appetite and investment objectives.
- Fixed Rate of Interest:
Debentures offer a fixed rate of interest to the holder. This helps investors to plan their income and expenses accordingly.
- Diversification of Portfolio:
Debentures offer investors an opportunity to diversify their portfolio. By investing in different types of debentures, investors can reduce their overall risk.
Disadvantages of Debentures:
- Credit Risk: Debentures are subject to credit risk, which means that if the issuer defaults, the holder may not receive the principal and interest on the debenture.
- Market Risk: The value of debentures may fluctuate due to changes in interest rates or market conditions. This may result in capital losses for the holder.
- Inflation Risk: Debentures offer a fixed rate of interest, which may not keep up with the rate of inflation. This may result in a decline in the purchasing power of the holder’s income.
- Illiquidity: Debentures are not as liquid as other investment options, such as stocks or bonds. It may be difficult for the holder to sell the debenture before its maturity date.
Debenture meaning in different Indian languages
| Language | Debenture Meaning |
|---|---|
| Hindi | डिबेंचर |
| Bengali | ডিবেনচার |
| Tamil | டெபந்சர் |
| Telugu | డెబెంచర్ |
| Kannada | ಡೆಬೆಂಚರ್ |
| Malayalam | ഡെബൻചർ |
| Marathi | डिबेंचर |
| Gujarati | ડેબેન્ચર |
| Punjabi | ਡਿਬੈਂਚਰ |
Note: The above meanings are transliterations of the English word “debenture” into the respective Indian languages. The meaning may vary slightly based on the context and usage.
Redemption of Debenture
Redemption of Debentures refers to the process by which a company repays the amount of debentures issued to the public at the time of issuance. Debenture redemption is an essential part of corporate finance as it helps companies manage their long-term debt obligations.
Debentures can be redeemed in several ways, including:
- Redemption at Maturity:
Debentures are issued with a specific maturity date, at which point the issuer is required to redeem the debentures in full. At maturity, the debenture holder receives the principal amount of the debenture along with any accrued interest.
- Redemption by Installments:
Debentures can be redeemed by the issuer in installments over a period of time. This allows the issuer to spread out its debt repayment obligations and manage its cash flow more efficiently.
- Redemption by Conversion:
Debentures can be redeemed by conversion into equity shares of the issuing company. This is known as a convertible debenture. The debenture holder has the option to convert the debenture into equity shares at a predetermined conversion price and ratio.
- Redemption by Purchase:
Debentures can be redeemed by the issuer through a process of purchase. In this case, the issuer buys back the debentures from the holder at a predetermined price or market price.
Redemption of debentures is typically governed by the terms and conditions set forth in the debenture agreement. The terms of redemption, such as the date of redemption, the amount to be redeemed, and the method of redemption, are specified in the debenture agreement.
Companies may choose to redeem their debentures early if they have sufficient funds or if they want to reduce their debt burden. However, early redemption of debentures may incur prepayment penalties or call premium, which is a fee charged to the issuer for early redemption of the debentures.
Debenture redemption is a crucial component of corporate finance. It enables companies to manage their long-term debt obligations and maintain a healthy balance sheet. The terms of debenture redemption are set forth in the debenture agreement and can vary depending on the type of debenture issued. Companies should carefully consider the terms and conditions of debenture redemption before issuing debentures to the public.
Difference between Shares and Debenture
| Aspect | Shares | Debentures |
|---|---|---|
| Definition | A unit of ownership in a company | A form of long-term borrowing by a company |
| Ownership | Represents ownership in the company | Does not represent ownership in the company |
| Returns | Dividends paid on shares are not fixed | Interest paid on debentures is fixed |
| Risk | Shareholders bear the risk of the company’s performance | Debenture holders have a fixed return and bear less risk than shareholders |
| Priority of payment | Dividends are paid after payment of all other obligations | Interest on debentures is paid before payment of dividends |
| Maturity | Shares do not have a maturity date | Debentures have a maturity date, after which they must be redeemed |
| Convertibility | Shares cannot be converted into any other security | Debentures can be converted into equity shares, which makes them convertible debentures |
| Voting Rights | Shareholders have voting rights in the company | Debenture holders do not have voting rights |
Note: The above differences are general in nature and may vary based on the specific terms and conditions of the shares and debentures issued by a company. Investors should carefully consider their investment objectives and risk tolerance before investing in either shares or debentures.
FAQs on Debenture
A debenture is a type of long-term debt instrument issued by a company to borrow money from the public. It represents a form of loan taken by the company, which is paid back with interest over a period of time.
The types of debentures include secured debentures, unsecured debentures, convertible debentures, non-convertible debentures, and redeemable debentures.
Secured debentures are backed by the assets of the issuing company, while unsecured debentures are not backed by any specific assets.
A convertible debenture is a type of debenture that can be converted into equity shares of the issuing company at a predetermined conversion price and ratio.
A non-convertible debenture is a type of debenture that cannot be converted into equity shares of the issuing company.
A redeemable debenture is a type of debenture that has a fixed maturity date, after which it must be redeemed by the issuing company.
Debentures and bonds are both long-term debt instruments issued by companies to borrow money from the public. The main difference between the two is that bonds are typically secured by specific assets of the issuing company, while debentures may or may not be secured.
The interest rate on debentures is determined by the issuing company and may vary depending on market conditions and the creditworthiness of the company.
Yes, debentures can be traded in the stock market. However, they are not as liquid as shares and may have lower trading volumes.
Investing in debentures carries a certain amount of risk, as the creditworthiness of the issuing company and the performance of the overall market can affect the value of the debentures. However, debentures are generally considered to be less risky than shares, as they offer a fixed return and are backed by the assets of the issuing company.
Conclusion
In conclusion, debentures are an important financial instrument used by companies to borrow money from the public. They offer investors a fixed return over a period of time, and are available in various forms such as secured and unsecured, convertible and non-convertible, and redeemable and non-redeemable debentures.
While investing in debentures carries a certain amount of risk, they are generally considered to be less risky than shares, as they are backed by the assets of the issuing company and offer a fixed return.
Investors should carefully consider their investment objectives and risk tolerance before investing in debentures, and should also be aware of the terms and conditions of the debentures issued by the company.
Overall, debentures provide a valuable source of long-term financing for companies, and can be an attractive investment option for investors seeking a fixed return with a lower level of risk.