Debentures / Bonds
A long-term security yielding a fixed rate of interest, issued by a company and secured against assets.
In corporate finance, adebentureis a medium- to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term "debenture" originally referred to a document that either creates a debt or acknowledges it, but in some countries the term is now used interchangeably with bond, loan stockornote. A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest. Although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital.Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoff for these categories.
Debentures are freely transferable by the debenture holder. Debenture holders have no rights to vote in the company's general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the company's financial statements.
Notes
- Provides a slightly higher rates than bank FDs
- Don't go from a 10 year term since equity will give you a higher return than debentures
What is Put Option in a NCD?
A put option in NCD means that the investor has an option to surrender the NCD if he wants to, and get back his/her principal. The put option provides the investor with a lot of flexibility. If NCD interest rates go up, and the investor can get better rates from the market, he can exercise the put option and get back his/her principal which can be invested elsewhere.
What is Call Option in a NCD?
A call option in NCD means that the company has an option to ask the investor to surrender the NCD in exchange for the principal investment. A call option gives flexibility to the company. If NCD interest rates go down, and the company can get funds at lower rates from the market, it can exercise the call option to give the money back and can raise money from the market at lower rates.
Types
Convertible Debentures (CD)
CD, which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time. "Convertibility" is a feature that corporations may add to the bonds they issue to make them more attractive to buyers. In other words, it is a special feature that a corporate bond may carry. As a result of the advantage a buyer gets from the ability to convert, convertible bonds typically have lower interest rates than non-convertible corporate bonds.
Non-Convertible Debentures (NCD)
NCD, which are simply regular debentures, cannot be converted into equity shares of the liable company. They are debentures without the convertibility feature attached to them. As a result, they usually carry higher interest rates than their convertible counterparts.
- Secured debentures - Backed by collateral, in time of backruptcy, assets are sold to pay debenture holders
- Unsecured debentures - No backed by any collateral
Others
- Fixed Rate Bonds: Has a coupon or interest rate fixed till the maturity of a bond.
- Floating Rate Bonds: Also, known as floaters where the interest rate is linked to reference rate such as MIBOR (Mumbai Interbank Offered Rate).
- Zero-Coupon Bonds: It does not pay periodic interest or coupon rate but is effectively rolled up to maturity and the bondholder receives the full principal amount at the redemption date.
- Convertible Bonds: This bond lets a bondholder exchange a bond to a number of shares of the issuer's common stock.
- Inflation-indexed Bonds: Inflation-indexed bonds are bonds in which the principal amount and the interest payments are indexed to inflation
- Perpetual Bonds: These bonds are also often called perpetuities or 'Perps'. They have no maturity.
What Is Debentures? Should You Invest In Debentures OR FD Explained By CA Rachana Ranade