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Fincash » Mutual Funds India » Debentures

What are Debentures?

Updated on May 16, 2024 , 3618 views

Debentures are unsecured debt instruments with no Collateral backing them up. They're a type of Capital Market instrument used to raise medium or long-term funds from the general public.

Debentures

They are simply financial instruments used to issue loans by businesses and the government. Debentures are a type of short-term funding used by private enterprises to fund prospective projects, develop their business, or raise cash. The interest rate on a Debenture might be fixed or floating.

Features of Debentures

Here are some of the most important features of debentures:

  • Debenture holders have no voting rights. On the other hand, they have the right to sue the company if their dues are not paid
  • According to a predetermined schedule, they are paid interest on a regular Basis
  • If a debtor defaults, the security can be enforced by selling the debt
  • They have the right to have their capital redeemed according to the conditions of the contract
  • To protect their interests, debtors might file a petition to wind up the firm
  • It comes in the form of a certificate stamped with the company's seal, known as a Debenture Deed
  • They are transferable by the holder of the debenture

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Types of Debentures

A company has the authority to issue several sorts of debentures, depending on its needs and objectives. Some of the types are as follows:

Secured and Unsecured Debentures

Secured debentures are the ones in which a charge is placed on the company's current properties or assets for the purpose of making a payment. The charge can be either floating or fixed.

Unsecured debentures are not secured by the company's assets. However, a Floating Charge may be imposed by Default on these debentures. Also, they are often not distributed

Convertible and Non-Convertible Debentures

Convertible debentures are financial instruments that, at the company's or the debenture holders' discretion, can be changed into equity shares or any other security. These debentures might be fully convertible or partially convertible.

On the other hand, non-convertible debentures are those that cannot be converted into shares or other securities. This category includes the majority of debentures issued by businesses.

Redeemable and Non-Redeemable Debentures

Redeemable debentures are those that are due at the end of the time period, either in one lump-sum payment or in instalments during the life of the business. These can be redeemed at a discount or at Face Value.

Non-Redeemable debentures are also known as Perpetual Debentures since the company does not make any attempt to recoup the money it has obtained or borrowed by issuing them. These debentures are repayable upon the closure of a business or the end of a protracted-time period.

Registered and Bearer Debentures

A registered debenture is one that gets included in the company's register of debenture holders. Its transmission necessitates performing a normal transfer deed. Bearer debentures, on the other hand, are debentures that can be transferred simply by delivery.

Specific Coupon Rate Debentures and Zero-Coupon Rate Debentures

The coupon rate on specific coupon rate debentures is fixed. The interest rate of zero-coupon rate debentures is usually not specified. Such debentures are circulated at a significant discount to recover investors. The difference between the nominal value and the circulating price is considered the amount of interest associated with the debentures' tenure.

Debentures vs Shares

Let's look at the main differences between debentures and shares based on the following criteria:

Basis Debentures Shares
Meaning Debentures are loans, and the company records them as debt Shares are a pillar of a company's capital, and issuing them serves to boost its market capitalization
Holder's known as Debenture holder shareholder
Holder's status Creditors Owners
Mode of return Interest Dividend
Payment of return Regardless of whether the firm has made a profit, the interest amount is paid to the debenture holders Dividends are paid out of a company's Earnings to its shareholders
Voting rights No Yes
Conversion Yes No
Trust deed Yes No
Payment security Yes No

Debentures vs Bonds

Let's look at the main differences between debentures and Bonds based on the following criteria:

Basis Debentures Bonds
Meaning Debentures are debt financial instruments issued by private firms that are not backed by any collateral or real assets Bonds are debt financial securities backed by collateral or physical assets that are issued by big enterprises, financial institutions, and government bodies
Secured by Collateral Can be either secured or unsecured Secured
Interest Offers high-interest rate Offers low-interest rate
Issued by Private companies The financial institutions, organizations, government agencies, etc
Risk High risk Low risk
Tenure Medium-short term investments, tenure is generally lower than bonds Long-term investments
Priority at Liquidation Second priority First priority
Payments It depends on the company's performance in the market It can be made monthly or annually

The Bottom Line

A debenture is a secure investment from the investor's perspective. Whether the firm earns a profit or loses money, the company is compelled to pay interest at maturity. Debentures are regarded as great instruments for obtaining guaranteed returns since the rate of return is set.

Disclaimer:
All efforts have been made to ensure the information provided here is accurate. However, no guarantees are made regarding correctness of data. Please verify with scheme information document before making any investment.

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