Debentures are debt instruments issued by companies and governments to raise funds from the public or institutions. When you purchase a debenture, you are essentially lending money to the issuer in exchange for periodic interest payments and the repayment of the principal amount at the end of a specified period. Debentures are a form of long-term debt financing.
Meaning of Debentures
Debentures are financial instruments that represent a company’s or government’s acknowledgment of debt and its commitment to repay the borrowed capital along with interest to the debenture holders at specified intervals. Debenture holders are creditors of the issuer and have a claim on the company’s assets in case of default.
Debentures typically include the following key features:
- Face Value: The principal amount borrowed, which is repaid at maturity.
- Interest Rate: The rate at which interest is paid to debenture holders, usually fixed or floating.
- Maturity Date: The date when the principal amount becomes due and is repaid to debenture holders.
- Interest Payments: Typically made semi-annually, annually, or as specified in the debenture terms.
- Security: Some debentures are secured by specific assets of the issuer, while others are unsecured (also known as “naked debentures”).
Kinds of Debentures
Debentures come in various forms to meet the specific financing needs and preferences of issuers and investors.
- Secured Debentures: These debentures are secured by specific assets or collateral of the issuing company. In case of default, debenture holders have a claim on the underlying assets. Secured debentures typically offer lower interest rates compared to unsecured debentures.
- Unsecured Debentures (Naked Debentures): Also known as “unsecured” or “naked” debentures, these are not backed by any specific collateral or security. Debenture holders rely solely on the issuer’s creditworthiness and general assets for repayment. Unsecured debentures usually offer higher interest rates to compensate for the increased risk.
- Convertible Debentures: Convertible debentures give debenture holders the option to convert their debt holdings into equity shares of the issuing company after a predetermined period or at specified conversion rates. This feature allows debenture holders to participate in potential capital appreciation.
- Non-Convertible Debentures (NCDs): Non-convertible debentures cannot be converted into equity shares. They remain as debt instruments throughout their tenor and are typically redeemed at maturity.
- Redeemable Debentures: Redeemable debentures have a fixed maturity date, and the issuing company is obligated to repay the principal amount to debenture holders upon maturity. They are also known as “callable” debentures if the issuer has the option to redeem them before maturity.
- Irredeemable Debentures (Perpetual Debentures): Irredeemable debentures, also known as “perpetual debentures,” have no fixed maturity date. They pay interest indefinitely, and the principal amount is not repaid unless the issuer exercises a call option.
- Zero-Coupon Debentures: Zero-coupon debentures do not pay regular interest. Instead, they are issued at a discount to their face value and redeemed at face value upon maturity. The difference between the issue price and face value represents the interest income for investors.
- Bearer Debentures: Bearer debentures are negotiable instruments that are transferable by physical possession, similar to a banknote. The holder of the debenture is entitled to the interest and principal when due. However, they are becoming less common due to regulatory changes and concerns about anonymity.
- Registered Debentures: Registered debentures are issued in the name of the holder and are recorded in the issuer’s books. The issuer pays interest and principal to the registered holder. These provide a greater degree of security and accountability compared to bearer debentures.
