Debentures Meaning - Guaranteed Returns But Better than FDs??

Vikas Yadav. Monday, August 30, 2021.

Not every product in the market is backed by collateral. Yet, almost everything in the market finds buyers. Some of them are bought because of the brand name or the endorser. Somewhat similar is the story of debentures. 

The instrument is somehow less talked about because of shares and bonds. But it is no less of importance and can be used to great advantage. Let's try to know more about the world of debentures.

Content:

  • What are Debentures?

  • Types of Debentures

  • Features of Debentures

  • Advantages of Debentures

  • Disadvantages of Debentures

  • Conclusion

What are Debentures?


Debentures are a type of debt instrument, just like bonds. However, there is one crucial difference. Debentures are not collateral-backed. This means they are not secured by collateral. Since this is the case, the value of the debenture depends on the reputation of the company or the party (read government) that has issued the debenture.

Now, any company or a government can issue debentures to raise money. Debentures carry a fixed rate for the investors and they are by nature long-term investments. 

Companies, which have good credit ratings, issue debentures to raise money instead of bonds, which are backed by assets. The reason is that a company would not want its assets tied up in a legal contract unless absolutely necessary.

However, they're important for the investor to note before investing in the debenture. If a company has issued debentures, it may be that all its assets are already tied up as collateral in other borrowings. This can deem a debenture risky.

Features of Debentures


Following are the features of a debenture:

  • This is a fixed-rate low-risk investment avenue. Since the issue — government or company — has credibility, it is a preferred investment because of the almost certain returns.

  • Regardless of profit or loss, the company is required to pay the amount to debenture holders at the rate of interest decided earlier.

  • Debenture holders — the investors — get preference over shareholders when payment is due in case the company goes bust. 

  • Despite not having the right to vote in the company, the investors can avail of legal avenues in case of any financial fraud committed by the company and get their returns.

Types of debentures


There are several types of debentures in the market. Let's take a look:

Secured Debenture

When a company's debenture has the backing of the assets of the company, it is called a secured debenture. The security can be some fixed asset of the company, like factory land. Such is called fixed charge debenture. if the security is a generic asset, then it is called floating charge debenture. Furthermore, they are classified into preferred or first mortgage debenture or second or ordinary debenture.

a) First mortgage or preferred debenture

The obligations of these debentures are met first at the time of realisation of the assets.

b) Second mortgage or ordinary debenture

These debentures of the company are serviced after settling the first mortgage debenture.

Unsecured Debenture

Such debentures do not have any backing of the assets of the company. They are issued by a company purely on its goodwill and creditworthiness.

Convertible Debentures

These are mixed financial instruments that have the advantages of both debt and equity shares. Investors who own convertible debenture can convert their assets into stocks. 

Such conversion is done after a certain period of time in accordance with the terms and conditions of the contract, with a specific ratio. They are further classified into partly and fully convertible and they behave as their names suggest.

Non-convertible Debentures

As the name suggests, the issuers — the company or the government — do not allow the holders to convert the debentures into stocks.

Redeemable Debentures

Investors can redeem their debentures on a predefined date as set in the contract. The issuer is legally required to fulfill this obligation. These are called redeemable debentures.

Irredeemable Debentures

Just the opposite of redeemable ones. There is no set date for investors to redeem the debentures. They are redeemed when the company liquefies or according to any condition set in the contract. Such debentures are not sold in the Indian market.

Advantages of Debentures


  • Debentures holders get paid first in any case, hence making the investment safer

  • A higher credit rating improves the safety quotient of the instrument

  • A good tool for long-term investment as the charges are not high

  • Fixed and sure rate of interest for investors. Has to be paid before the dividends are issued to shareholders

Disadvantages of Debentures


  • Since they have to be paid no matter what, it can force a company into insolvency as well. Hence only very strong companies issue it.

  • No voting rights in the company

  • Checking the creditworthiness of every company is not easy for each company

Conclusion


Debentures are long-term, secure investments that any investor would look for. Just that they are not issued in great numbers and are not the most popular product in the market. 

So, if an investor already has made investments using several tools, then they can look out for debentures, provided they can find out about the credit rating of the issuer. It is not a bad investment tool. It needs to be dealt with prudence as there may not be many with the knowledge of this product.









Disclaimer: The above article is written for educational purposes, and the companies’ data mentioned in the article may change with respect to time.

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Author : Vikas Yadav
Vikas Yadav

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