As the issue of debentures introduction, it is a debt instrument that organisations issue for investors to raise capital. Therefore, it is mainly an asset class that serves the long-term capital requirements of a company. Besides, it carries an extended period of maturity at a fixed rate of interest payable periodically such as quarterly, semi-annually, or annually.
For instance, let’s assume that a company ABC issues bonds worth Rs.1,000 in the secondary trading market. Therefore, bondholders have a legal claim to Rs.1,000 worth of ABC’s assets. However, in case of debentures, holders lack the legal ownership of ABC’s assets.
It is primarily due to the fact that debentures are not backed by assets. As a result, creditworthiness coupled with the appropriate market rating generate the confidence of
investors in this debt instrument.
What are Debentures?
Moving on to the definition of debentures, it is a category of corporate debt that is not supported by collateral. As a result, the companies that issue debentures do not have to pledge their assets to fulfil their capital requirements. On top of that, the trust of the issuer is an important element in its financial validity in the market.
Apart from business organisations, governments also use debentures to fund their infrastructure initiatives. As these organisations do not pledge their assets during debenture issue, traders can earn higher profits from their transactions. Consequently, debentures are traded in the debt market through a network of investment brokers.
Besides, investors receive debentures in the form of official certification from the issuing organisation. Therefore, these corporations are legally obligated to repay the principal amount invested by an individual after a stipulated period. In addition, the interest that accrues on the principal amount is fixed. Therefore, debentures are an investment avenue that is often referred to as ‘fixed cost bearing capital’.
For example, suppose an investor Mr. Jones purchases a debenture with a face value of Rs.50,000. The rate of interest applicable is 10% per annum for 5 years. Therefore, Mr. Jones will receive a fixed interest payment of Rs.5,000 every year.
However, the issue of debentures showcases a wide range of features that separate it from other categories of security.
Test Your Knowledge
Consider that the face values of two debentures are Rs.100 each. Debenture A is available at a market price of Rs.85. On the other hand, Debenture B has a market price of Rs.120. Figure out which debenture is discounted and which one is a premium.
What are the Features of Debentures?
The most prevailing and prominent features of debentures include the following pointers –
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Redeemable and Irredeemable Debentures – These two types of debentures differ on the degree of time involved in the repayment process. First of all, redeemable debentures make sure that issuing corporations fulfil their repayment obligations to holders. Therefore, the investors are eligible to receive the principal amount combined with the interest portion after a pre-determined period of time.
On the other hand, the companies that issue irredeemable debentures have no legal obligation to pay the principal amount to holders. However, they must pay the interest on the face value of the debenture as specified intervals.
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Convertibility of Debentures – A specific section of debentures have the tendency to exhibit convertibility in terms of asset class. Therefore, investors can convert their debentures into equity shares after a tenure. This category of debentures has a conversion ratio which specifies the proportion of shares in exchange of the face value of a bond. For instance, Mr. Jones is eligible to get 10 shares for a debenture with a principal value of Rs.1,000. Therefore, the convertibility ratio is 10:1.
Contrarily, non-convertible debentures lack the option to be converted into equity shares at any points of time. Non-convertible debentures usually offer a higher rate of interest than ordinary convertible debentures. Moreover, the issue of debenture in this category is exposed to lower market risk and has an increased liquidity.
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Rank During Liquidation – Debentures and bonds both precede shareholders in terms of receiving debt after a company goes bankrupt. For example, consider that a company ABC faces bankruptcy in the debt market. On liquidation of its assets to repay the creditors, debenture holders are at the beginning of the order. Therefore, companies issue first debentures for creditors who want to recover their sum of investment.
However, second debentures imply that the holders case receive their repayment after other debts are taken care of.
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Market Value of Debentures – Even though debenture issue is at face value, it so happens that the market price often dips or rises. In case the market price is lower than the face value, the debenture is said to be discounted. However, if the market price exceeds the face value, the debenture is a premium issue.
Therefore, keeping the features in mind will help a student understand the operations of the debt market. However, if you want a detailed insight into the interesting world of issue of debentures, visit the official website of today!