What is a Debenture?

Debenture is a type of Debt instrument which offers a fixed rate of interest for a specified tenure. Companies or governments use debentures to borrow money. Debentures are simply loans taken by the companies and do not provide the ownership in the company.

Bonds and Debentures have lot of similarities, both offer fixed interest rate and they have fixed tenure. But, bonds can be more secured than debentures. For this reason bond holders receive a lower rate of interest when compared to Debentures coupon rates. Bonds(Ex – Tax Free Bonds)are mostly issued by Government firms / entities.

Types of Debentures

There are various types of debentures, issued by any company, to raise fund for long term. Which are given below:

Convertible debentures are the ones that can be converted into equity shares at a later time. This convertibility provides attraction to the investor but yield lower interest rates.

Non convertible debentures does not convert into equity shares thus can yield a higher interest rate.

  1. Secured NCDs are backed by the issuer company’s assets to fulfill the debt obligation.
  2. Unsecured NCDs there is no backed by the issuer company’s assets to fulfill the debt obligation

Redeemable Debentures is a debenture which is redeemed/repaid on a prede¬termined date and at predetermined price.

Non-redeemable Debenture are generally not redeemed during the lifetime of the company. So, it is also termed as perpetual debt. Repayment of such debenture takes place at the time of liquidation of the company.

How to buy NCDs?

Public Issue: During the public issue of the bonds, you can invest in them by submitting a physical form furnishing the details as requested. Also, you can make an investment online through your Demat Account.

Secondary Market: NCDs bonds are listed on NSE or BSE or at times on both after the Public Issue. You can invest in these bonds through your trading account like the way you invest in shares. (But do note that NCDs have liquidity risk. Even if NCD get listed, low volumes can deprive investors of any opportunity in exiting prematurely.)

 

Non-Convertible Debentures (NCDs) generally offer returns in the range of 9% to 12%. The investor must put in good research behind his choice of Issuer since these products have a certain extent of credit risk for the investor.

Features of Debentures:

  1. Debenture holders are the creditors of the company carrying a fixed rate of interest.
  2. Debenture is redeemed after a fixed period of time.
  3. Debentures may be either secured or unsecured.
  4. Interest payable on a debenture is a charge against profit and hence it is tax deductible expenditure.
  5. Debenture holders do not enjoy any voting right.
  6. Interest on debenture is payable even if there is a loss.

Advantage of Debentures:

  1. Interest on debenture is tax deductible expenditure and thus it saves income tax.
  2. Cost of debenture is relatively lower than preference shares and equity shares.
  3. Issue of debentures is advantageous during times of inflation.
  4. Interest on debenture is payable even if there is a loss, so debenture holders bear no risk.

Disadvantage of Debentures:

  1. Payment of interest on debenture is obligatory and hence it becomes burden if the company incurs loss.
  2. Debentures are issued to trade on equity but too much dependence on debentures increases the financial risk of the company.
  3. Redemption of debenture involves a larger amount of cash outflow.
  4. During depression, the profit of the company goes on declining and it becomes difficult for the company to pay interest.

Difference between Debentures and Bonds

  1. Bonds are secured in comparison to debentures
  2. Bonds are usually issued by the government bodies while debentures are issued by private companies.
  3. Bond offers lower interest rate in comparison to debentures
  4. Bondholders do not receive periodic payments and receive the principal plus interest at the end of the term whereas debenture holders receive periodic interest payments.
  5. Bond is a long term debt instrument that promises to pay a fixed annual interest over a specific period whereas debenture is a medium term debt instrument.