The Ultimate Secret Of Debenture

A debenture is a long-term debt instrument used by large enterprises to borrow money from the public. This includes a fixed rate of interest and is not secured by any collateral, unlike other debt instruments. They are upheld by the creditworthiness and goodwill of the company. It is a certificate of loan that proves that the company is liable to pay back a specified amount of money with interest. Companies use debentures as long-term loans. This is advantageous for the company as they carry a lower interest rate than other debt instruments. These debentures have a fixed rate of interest and a fixed day for repayment. The debentures are documented in the indenture where the maturity date, method of interest calculation, and other features are recorded. Both businesses and the government can issue debentures. Treasury bonds and treasury bills are debentures issued by the government.

(Source: Ipleaders Blog)

Companies usually issue debentures for the expansion of the organization, they do this by borrowing money at a fixed rate of interest. This borrowed money has to be repaid at a future date. This amount can be paid back yearly or half-yearly. This makes the debenture holders the creditors of the company but they do not get any voting rights in the company. The debenture holder can freely transfer the debenture. The company should make sure that the amount should be repaid to the debenture holders even if the company goes through bankruptcy.

Types of Debentures:

1. Convertible Debentures

These debentures are a type of unsecured long-term debt that can be converted from debt to equity shares after some time. They possess the features of both debt and equity investments. It can be either converted partly or wholly. They are usually unsecured bonds or bonds with no collateral backing up their debt. Convertible debentures have lower interest rates as the debt holder has the option to convert the loan to stock, this can turn out to be a profit for the investor.

1. Non-Convertible Debentures

These debentures can be converted into equity shares. It is issued by the companies to raise more money from the investors. They have a higher interest rate than convertible debentures that attract lenders. They are used by companies to raise long-term capital and have a fixed maturity date. They do this through the public issue. Non-convertible debentures offer various benefits such as tax exemptions, high returns, high liquidity, and low risk as compared to convertible debentures.

Are debentures a safe way to park your money?

Debenture holders have to face less risk as compared to other shareholders. In case of bankruptcy also debenture holders are given first preference in the repayment process. They are repaid even before the companies shareholders. So the risk element for the debenture holders is much lesser as compared to the shareholders. Debentures are also secured by the issuer’s asset, so this also ensures the repayment even if the company faces a financial strain.

Advantages of Debentures:

• Debentures are comparatively cheaper and provide longer repayment dates as compared to other debt instruments.

• Debentures are the best option for investors who prefer lesser risk and steady income.

• The profit of the company is not involved with the debentures.

• The debenture holders do not have voting rights, so this doesn’t dilute the decision-making authority of the other members in the management.

Disadvantages of Debentures:

• The interest that has to be paid for the debenture holders is a financial burden for the company because even if the company is going through a financial strain they still have to pay back the debenture holders.

• Redemption of debentures can imbalance the liquidity of the company’s cash flow.

• Since every company has a specified borrowing capacity. Issuing debentures can reduce the company’s borrowing capacity.

• The debenture holders might have to face the inflationary risk sometimes. This may cause the future real value to reduce.
  

The word “debenture” was derived from the Latin word “debere” which means to borrow. It is the most common way used by large companies to borrow money. While issuing a debenture, a trust indenture should be drafted. This trust is an agreement between the issuer of debenture and the investors about the interest rate of the debentures. The coupon rate that determines the interest rate can either be fixed or floating.

Credit rating agencies help the investors measure the creditworthiness of the company or government that issues the debenture. They also provide an overview of the risk involved in investing. Moody’s Investor Service, Standard and Poor’s(S&P), Fitch Group are some of the famous credit rating agencies.

(Source: Business News Daily)

The maturity date is an important feature while issuing a debenture. It is the date that mentions when the company should pay back to the debenture holders. On the maturity date, the issuer of the debenture pays back the money. This repayment is usually done from the company’s capital. Even if the company is bankrupt, the debenture holders are paid back before the stock shareholders.

Muthoot Finance, Reliance Capital, Tata Global Beverages, Shriram Transport are some of the companies that issue debentures to the public. There are also government holdings such as the Indian Railway Finance Corporation, National Highway Authority of India that issue debentures.

Debentures are a financial instrument that does not bring in a lot of risks to the debenture holders. It is also a debt instrument that has lesser interest rates as compared to the others. All these features of the debentures make it a common and most preferred financial instrument among the public who prefers to invest.

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Author - Aleesha Vithayathil

Content Writer at Escribo.