Published : December 19, 2020
A debenture is a debt instrument that is used by corporations to borrow money for the medium to long term. These are the most common types of financial instruments that can be taken by a company. Debentures are generally repayable on a fixed date; however; some debentures are irredeemable. Most debentures are secured on credit history and based on the borrower’s assets. However, some debentures such as unsecured debentures are not based on collateral. A fixed-rate of interest is paid in most debentures, and the interest is paid before the dividend is paid to shareholders. For example, Muthoot Finance has issued its Non-Convertible Debenture in 2020, which has an interest rate of 7.35% and maturity of 60 months.
There are two types of debentures convertible and non-convertible debentures. Let’s discuss both the types in detail-
Convertible Debentures: Debentures that can be converted into equity shares of the issuing company after the predetermined period of time are called convertible debentures. These types of bonds are more attractive for investors as they have options to convert into equity shares. Moreover, it is also popular among companies as they have to pay a low rate of interest as compared to non-convertible debentures.
Non-convertible debentures: Debentures that cannot be converted into equity shares are called non-convertible debentures. These debentures carry more interest rates as compared to convertible debentures as they are not able to convert.
Debentures have advantages for both companies and investors. Let’s look at both in detail-
Advantages for Investors: Debentures provides a regular and fixed income for investors, so it is a safe investment option for investors. It has a fixed maturity date, which also attracts investors. A loan can be obtained from financial institutions by keeping the debenture as a mortgage. The interest of debentures is also protected by SEBI, which adds to the safety of this instrument. When it comes to liquidation, the debenture holders get the money first.
Advantages for Company: Debenture investment is made for long terms, so it provides money for a longer duration to the company. The company pays more in terms of dividends than debenture interest which makes it less expensive for the company to raise money. The finance happens in debt form, so the voting right is not given to debenture holders. When the stock market sentiment is weak, the money can be raised through debentures by giving an assured return to investors.
Debentures have disadvantages for both companies and investors. Let’s look at both in detail-
Disadvantages for Investors: Debenture holders do not have any voting rights over the management of the company. Interest income on debentures is taxable while shareholders may also get a dividend in terms of stocks rather than cash. They fluctuate in the market when there is a change in interest rate.
Disadvantages for Company: There is a legal obligation to pay the interest plus principal to investors, so the company has to pay money to debenture holders even if it made a loss in that time duration. Stamp duty is high when financing through debentures which is negative for the company.
Conclusion: Debentures are good for both companies and investors. Investors have the advantage of a fixed return, and the company has the benefit of long term financing. There are some disadvantages too of debentures, but advantages outweigh those. It gives better returns than other fixed income instruments, so investors have the benefit of more interest.
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