An Ultimate guide to Debentures Meaning and Its Working

Today the listed companies are no longer running behind the commercial banks for credit, but are simply issuing debentures for different interest rates such as 6% debenture, 9% debentures or 12% debentures. However debentures carry out their own benefits, features and structure that one has to consider before picking the right option between debentures and equity. To know about debentures, features of debentures or debentures meaning, you should certainly consider reading the complete article.

What is Debenture?

Let us predominantly understand, what is debenture? A debenture is a kind of bond or any other debt tool that is devoid of any backing collateral. Its mere support typically comes from the issuer’s creditworthiness and reputation, since debentures have no collateral base. To raise funds or accumulate capital this kind of obligation is often raised by corporations and governments.

Similar to other bonds, debentures may pay a regular amount of interest known as coupon payment at stipulated intervals. Just similar to the rest of the bonds, all debentures are recorded in an indenture. This indenture is also a legally binding agreement between issuers and holders of bonds under which different features are provided in relation to a loan issue including maturity date, time at which interest or coupon payments are to be made, interest calculation method among others. Any corporate entity or even a government can issue debentures. Thus, this is the sole debentures meaning and its working.

Are debentures different from bonds?

In simple words, a debentures meaning is a bond without security. It is an unsecured or non-collateralized liability issued by a business enterprise or any other organization with the implication being that such liabilities have more time till they get to full maturity as compared to the ordinary ones. Collateralized debts are guaranteed through provision of assets such as securities, properties and other liquids which could be sold in order for the lender to recover part of his money back should the company fail to honour its obligations as scheduled. On the contrary unsecured debentures pose higher levels of risk due to lack of collateralization.

What is the structure of a debenture?

All debentures go through the same basic structuring and have similar characteristics. The first step is to draw up a trust indenture, which is a contract between the issuer and the organization that represents bondholders’ interests. After that, the interest rate on coupons is set. It represents the percentage of money that a corporation will give to an investor or debenture holder. This rate may either be constant or floating and it is often subject to some credit rating issued either by the firm or by the bond itself. They can also be into common stock either as convertible or non-convertible debentures.

A debenture is a liability for the issuer since it’s a debt instrument whereby they essentially borrow money by issuing these securities. According to the investor (bondholder), ownership of such investment represents an asset which some authors describe as meaning he holds claim against firm assets in case it goes bankrupt.

What is Convertible Debentures?

These are generally debt securities that have an inherent right to convert them into a given number of stocks of the issuing company at a fixed price (conversion price) on or within a specific date (maturity). So, What is convertible debenture? In simpler terms, it’s a debt-equity instrument.

How Convertible Debentures Work?

Consider that you invest in a convertible debenture. The bonds pay you regular interest payments as well. But If the stock of the issuing company appreciates over time, you may opt to convert the convertible debenture into shares and obtain significant capital gains. One of the main advantages of convertible debentures is that the investor has an option to convert to an equity in the company when it grows.

Benefits of Convertible Debentures

There are several features of convertible debentures that appeal to an investor to buy them. Some of the benefits of Convertible debentures include:
For Investors:

• Potential for Capital Appreciation: You can convert the convertible debenture into a stock if the stock price increases.
• Steady Income: You enjoy regular interest payments throughout the term of the convertible debenture.
• Lower Risk: Relative to common stock, convertible debentures are less risky because they have a fixed face value upon maturity.

For Companies:

• Lower Cost of Capital: Unlike common stock, with convertible debentures a company may be able to raise capital at a cheaper price since the company with high growth potential will attract many investors.
• No Dilution of Ownership: unlike issuing new shares to the investors, convertible debentures do not immediately dilute existing shareholders’ ownership stake.

Comparing Convertible and Non Convertible Debentures for better understanding

Well, there are various types of debentures but let us solely discuss how different are convertible and nonconvertible debentures below:

Convertible debentures:

Convertible Debentures are regarded as hybrid in nature because they combine features from both debt and ownership investor’s points of view. Such a firm usually employs debentures as its interest-bearing obligations with a fixed interest rate. Nevertheless, owners of such securities can either leave the principal unpaid (yet still be entitled to receive interests prior to redemption date) or exchange it for shares.

Convertible debentures are beneficial to investors who desire it to be changed into equity in a case where they believe that the company’s stock prices will go up over a long period of time. Nevertheless, the opportunity to convert debentures into equity has a cost since, unlike other fixed rate income securities, this kind pays very little interest.

Non-convertible debentures

Nonconvertible debentures are conventional debentures that cannot be changed into stock of the business that issued it. To make up for the absence of convertibility investors get paid more interest on nonconvertible debentures than they do on convertible ones.

Non convertible debentures are beneficial for the investors who look for massive returns, liquidity, low risk and tax benefits when compared to that of Convertible debentures. Investors can purchase when a company first offers NCDs or purchase them later on the secondary market. Before investing, go through the company’s credit rating, trustworthiness and the coupon rate(interest rate) of the Non Convertible Debentures.

Distinct features of debentures

Debentures are a crucial financial instrument for companies looking to raise funds from investors. They come with various different features that make them attractive to both issuers and investors. These features include:
Interest rate
The cost of borrowing is represented by the interest rate on debentures, which is a percentage of the principal, and shows what investors get back for lending company funds. For example, if a debenture worth INR 1000 had an interest rate of 5% then the debenture would be earning INR 50 per year. It may change due to different things like market situations, the company’s solvency, term length regardless of anything else.
Maturity date
In simple language, the maturity date of a debenture is the actual date when the capital invested will be paid back to the people who invested. This date is predefined and works as a yardstick for the tweedle-dee and tweedle-dum; enabling them to strategize financially.
Convertibility
Convertible debentures give holders an opportunity to change them into company’s stock. If the investors are interested in the company’s growth and making profits, this provision helps them. At the time of giving this debt, the number of shares annexed to them is set in advance.
Callability
Certain debentures have callable features which gives the company the authority to buy back the investors’ debentures prior to their initial maturity date. It may be exercised if such companies feel that they could borrow money again more cheaply elsewhere. Even in a forced amalgamation between two companies into one entity, debenture holders would still be offered higher than prevailing market interest rates and thus they should not complain about any premium paid.
Credit rating
The credit rating of a debenture is ultimately a reflection of the company’s credit rating with regard to the interest an investor will earn. Credit-rating agencies judge how well a company or government may pay its debts. They also give an idea about the fundamental risks in putting money in securities.

Perks of considering debentures

Considering debentures, it has some of the exceptional advantages. Some of its perks that you need to know:

1. Debentures are debt tools that a company can use to get loans without diluting its equity.
2. The debenture interest incurred is debited to the issuing company’s earnings. The interest
3. expenditure becomes eligible for a tax allowance which lowers the taxable income for a business.
4. You can easily trade debentures on the stock exchange since they are liquid assets.
   Unlike other borrowing sources, debentures have lower interest rates than any other debt instruments.
5. Receiving interest payment is guaranteed even in times of financial loss for the company, thus protecting the holder from chances of borrower failure to repay.
6. Getting loans through debentures is profitable even during inflation because of their fixed rates of interest.

Investing in stocks or debentures might seem like a cake walk, but one needs to have adequate knowledge before choosing the right company with great fundamental and technical aspects. And in such a hectic schedule it’s indeed complicated to do a thorough research about what is debenture, debentures meaning, what is convertible debentures or features of debentures. You no longer have to worry about that as SMC Global Securities is at your support. It is an exceptional platform with expertise who will precisely guide you through your investment journey.

Conclusion

Debentures are popular investment instruments among both investors and companies. They make an excellent choice for companies in need of funds because they are cheap to borrow and without equity dilution. Additionally, there are other attractions like tax concession and flexibility in issues that make it good to have one. Then again, it is important for investors to look at factors such as credit rating, yield and market conditions before buying debenture.

References:

https://www.investopedia.com/terms/d/debenture.asp

https://www.bajajfinserv.in/