A debenture refers to a financial instrument used by companies for borrowing funds from investors over a medium to long-term period. In exchange for the loan, the company promises regular interest payments to the investors holding the debentures, with the principal amount slated for repayment on a specified future date.
- What Is Debenture?
- Example Of Debenture
- Debenture Certificate
- How Do Debentures Work?
- Characteristics Of Debentures
- Explain The Various Types Of Debentures
- Benefits Of Debentures
- Disadvantages Of Debentures
- Debenture Vs Bond
- Debentures Meaning – Quick Summary
- What Is Debenture? – FAQs
What Is Debenture?
A debenture is a medium or long-term financial instrument issued by a company when it wants to borrow money from investors. The company pays a regular interest to the debenture holders and repays the principal amount at a predetermined date.
There are two main types of debentures: convertible and non-convertible. The holder of the convertible debenture can choose to turn it into shares of the company’s equity. This conversion can happen at certain times and for a price already set.
On the other hand, non-convertible debentures are a type of debt that cannot be turned into equity shares of the liable company. They are just regular debentures that have higher interest rates than convertible debentures.
For instance, consider ABC Ltd., a well-established Indian company. If ABC Ltd. wants to expand its operations but lacks sufficient capital, it can issue debentures to raise funds. Investors who buy these debentures lend money to ABC Ltd., and in return, ABC Ltd. promises to pay them a fixed rate of interest during the life of the debenture. At the end of the term, ABC Ltd. repays the principal amount to the debenture holders.
Example Of Debenture
An example of debentures issued by Dewan Housing Finance Corporation Ltd (DHFL) in 2018. The company had issued non-convertible debentures with an interest rate of 8.9%-9.10% p.a. and varying maturity periods, offering investors an attractive return compared to bank savings interest rates. The investors were paid interest annually, and the principal amount was returned to the debenture holders at maturity.
However, the company later defaulted on its payment, demonstrating one of the risks of investing in debentures.
A debenture certificate is a legal document issued by a company to its debenture holders, acknowledging its debt. It contains details such as the holder’s name, the debenture’s face value, the interest rate, and the maturity date.
For example, when Tata Motors issues debentures to its investors, it also issues a debenture certificate to each investor. This certificate serves as proof of investment and outlines the terms and conditions of the debenture, including the obligation of Tata Motors to pay periodic interest to the investor and repay the principal amount on the specified maturity date.
How Do Debentures Work?
When a company issues a debenture, it’s essentially borrowing money from investors with the promise to repay the amount in the future, along with regular interest payments.
Here is the process of how debentures work:
- Issue of Debenture: The company releases a debenture offer for investors, indicating the interest rate, tenure, and other details.
- Investment by Public: Interested investors buy the debentures and provide the company with the needed capital.
- Interest Payment: The company makes regular interest payments to the debenture holders at predetermined intervals.
- Repayment of Principal: Upon maturity, the company repays the principal amount to the debenture holders.
Characteristics Of Debentures
The primary characteristic that distinguishes them from other financial instruments is the ability to deliver a fixed rate of interest to their investors.
Other characteristics include:
- Repayment of Principal: The principal amount is repayable after a fixed period.
- Secured or Unsecured: Debentures can be either secured (backed by assets) or unsecured.
- Convertible or Non-Convertible: Some debentures can be converted into shares of the issuing company after a specified period.
Explain The Various Types Of Debentures
Types of debentures include Secured and Unsecured Debentures, Convertible and Non-Convertible Debentures, Redeemable and Irredeemable Debentures, and Registered and Bearer Debentures.
- Secured and Unsecured Debentures: Secured debentures are backed by the company’s assets, whereas any collateral doesn’t back unsecured debentures.
- Convertible and Non-Convertible Debentures: Convertible debentures can be converted into equity shares of the company after a certain period, while non-convertible ones cannot.
- Redeemable and Irredeemable Debentures: Redeemable debentures can be redeemed (paid back) after a period, whereas irredeemable ones cannot be redeemed.
- Registered and Bearer Debentures: Registered debentures are registered in the holder’s name, and the interest is paid to the holder, whereas bearer debentures can be transferred, and the holder can claim the interest.
Benefits Of Debentures
The main benefit of investing in debentures is a fixed rate of income. Debenture holders are entitled to a fixed amount of money at a certain time, regardless of whether the company is making money.
There are a number of benefits to investing in debentures. Here are a few:
- Regular Income: Debentures pay a fixed interest rate periodically, providing a regular income for the investors.
- Security: Secured debentures are backed by the company’s assets, offering security to the investors.
- Higher Returns: Debentures typically offer higher interest rates than savings accounts and low-risk investments.
- Option for Conversion: Convertible debentures allow investors to convert their debentures into equity shares.
Disadvantages Of Debentures
Debentures have some drawbacks despite the advantages they offer. Some of them include:
- Risk of Default: In the event of company failure, there’s a risk that debenture holders might not get their investment back.
- Interest Rate Risk: If the market interest rates rise, the fixed debenture return could become less attractive.
- No Ownership Rights: Debenture holders do not have any voting rights in the company as they are creditors, not owners.
- Lack of Collateral: Unsecured debentures are not backed by any collateral, which means investors carry a higher risk.
Debenture Vs Bond
The main difference between debentures and bonds is, Debentures are usually unsecured, whereas bonds are typically secured.
|Issuer||Private Companies||Government or Public Corporations|
|Risk Level||Higher due to a lack of collateral||Lower as assets usually back it|
|Interest Rates||Generally higher due to higher risk||Generally lower due to lower risk|
|Conversion||Can be convertible into equity||Usually non-convertible|
Debentures Meaning – Quick Summary
- Debentures are long-term financial instruments that companies use to borrow money. They are debt instruments with a fixed interest rate and a specified repayment date.
- An example of a debenture is the one issued by Tata Motors in 2019 to raise funds for business expansion.
- A debenture certificate is a document that outlines the terms and conditions of the debenture.
- Debentures work by providing regular interest payments to investors, who can also redeem them at maturity.
- Characteristics of debentures include fixed interest rates, secured or unsecured nature, and potential for conversion into equity.
- Debentures include convertible and non-convertible, secured and unsecured, and registered and bearer debentures.
- To invest in debentures, one needs a Demat account, which involves researching, purchasing, monitoring, and redeeming the debenture.
- Start your investment in debentures at Zero Cost with Alice Blue.
What Is Debenture? – FAQs
What is a debenture in simple terms?
A debenture is a loan taken by a company that is repaid with a fixed rate of interest.
What are the 4 types of debentures?
The four types of debentures are:
- Convertible Debentures
- Non-Convertible Debentures
- Secured Debentures and
- Unsecured Debentures.
What is the difference between debenture and bond?
The main difference between a debenture and a bond is that debentures are typically unsecured, whereas bonds are secured.
What are the advantages of debentures?
Debentures offer several benefits, including the
- Stable and consistent income, as well as the
- Possibility of increased returns
Who issues debentures in India?
Debentures are a type of debt instrument that can be issued in India by organizations located in either the public or private sectors of the country’s economy.
Is debenture a stock?
No, a debenture is a debt instrument, not a stock. It represents a loan taken by the company, not ownership in it.
What is the Difference Between a Debenture And Loan?
The main difference between a debenture and a loan is that a debenture is issued to the general public, whereas a loan is an agreement between a lender and a borrower.
What is the rate of interest on debentures?
The interest rate on debentures varies depending on several factors, including the issuing company, the duration of the debenture, the prevailing market interest rates, and the issuer’s creditworthiness. As of 2023, interest rates typically range from 7% to 12% per annum in India, but they can be higher or lower depending on the factors mentioned.
Who can buy debentures?
Debentures can be bought by anyone – individual investors, companies, and institutions. The key requirement is that the buyer has a Demat account to hold the debentures. You can open a demat account with Alice Blue.