What Is Debenture and How Many Types Are There?

What is debenture and how many types are there?

Companies and government agencies require capital from time to time and fulfill this need through many methods like loan, stock market, public issue, institution investment etc. If we talk about loan, then apart from taking loan from the bank, it can also take loan directly from the common people and it does this through debentures. Debentures are certificates issued by companies in exchange for which they commit to give a fixed return to investors. Investment in debentures is a good means for us to earn good returns at low risk. In today’s article “Debenture meaning in Hindi” we will try to give you complete information about Debenture.

What is Debenture?

Debentures are a way through which companies can raise money from people in the form of loans. Debentures are issued by government agencies and companies when they need money, in return for which they pay a fixed interest rate. Generally debentures have a fixed maturity period. In exchange for investing in debentures, companies give the investor a legal certificate which contains details of the amount invested and the interest rate received. When the debentures mature, the investor gets a fixed interest amount as return along with the principal amount. However, if debentures are listed in the secondary market i.e. stock exchange, they can be sold through trade even before maturity.

The interest rate on debentures depends on its credit rating, market reputation and creditworthiness of the issuing company. We can take this interest rate either cumulatively i.e. at one time on maturity or non-cumulative i.e. at regular intervals like monthly, annually.

How many types of debentures are there?

Companies keep issuing debentures from time to time to raise money. These can be of different types according to their needs, which are:

Secured Debentures: Such debentures are secured by some kind of asset or collateral. If in any case the company defaults, the money is recovered by auctioning the mortgage security.

Unsecured Debentures: These debentures do not have any security or asset to back them up. These debentures are completely based on the creditworthiness and goodwill of the company.

Convertible Debentures: In such debentures, the debenture holder has the option to convert them into equity shares of the company in future. When debentures are issued, all the information related to it like conversion rate, conversion date, term and conditions etc. is told to the holder. These debentures can be fully or partially convertible.

Non-Convertible Debentures: Such debentures cannot be converted into equity shares in future, hence the interest rate available in these is also higher than ordinary debentures.

Redeemable Debenture: The maturity or interest payment date of this type of debenture is fixed. That is, these debentures are issued with a fixed maturity period where the investor is returned his money with interest after a certain time.

Non-Redeemable Debentures: Such debentures do not have any fixed maturity date. The interest rate available in these is periodic and is paid as long as the company is in existence. Investors can redeem debentures only when the company is going bankrupt or is being closed down. As of today, no company in India issues such debentures.

Fixed Interest Rate Debenture: As the name suggests, the interest rate on such debentures is fixed. This interest rate is declared by the company at the time of issuing debentures.

Floating Interest Rate Debentures: Such debentures do not have any fixed interest rate. Their interest rates vary depending on market conditions and benchmarks.

Registered Debenture: In this type of debenture, the name, address and all the information of the investor is given, that is, these debentures are registered in the name of one person and the amount of interest and maturity of the person in whose name they are registered. is also given only to him

Bearer Debenture: No information about the investor is given on such debentures and they are transferable. The person who holds these debentures can also claim the applicable interest on it.

How much return is given in Debenture?

The return received on debenture investment is called coupon rate or interest. The creditworthiness and rating of the company matters a lot in determining the coupon rate. This rating is determined by different credit rating agencies, information about which is available online or in the public notice of the debenture. The better the rating, the more secure the investment is, but the interest rate is also lower. At the same time, lower credit rating means more risk and to cover this, higher interest rates are also offered. In fixed interest debentures the interest rate remains fixed till maturity but in floating interest rate debentures it can be more or less.

How to invest in Debenture?

Whenever a company or government organization wants to issue debentures, it issues a public notice. The debenture opens for subscription on a fixed date during which you can buy it directly from the company’s office or its website. After the subscription is closed, some debentures get listed in the secondary market i.e. stock exchange where you can easily invest in them through your broker like zerodha etc. Keep in mind that even if you are applying physically for debentures, you must open your demat account because most of the debentures are issued in de-materialized form and are stored in your demat account.

Taxation on Debentures

Taxation on debentures can be applied in two ways. One is in the form of interest income and the other is in the form of capital gain. When you hold the debenture till its maturity, you get returns as per the interest rate on the principal amount invested. While paying income tax, this interest income is taxable as per your tax slab. When you file ITR, this interest income has to be declared under income from the other source.

The second is capital gains tax which is applicable when you sell the debenture by trading in the secondary market or stock exchange before maturity. In such a case, if you sell it before one year then short term capital gain is applicable on it and if you sell it after one year then long term capital gain is applicable on it. Short term capital gain is applicable as per your tax slab while long term capital gain is applicable at 10% without indexation and 20% after indexation (whichever is lower).

Benefits of Debenture

Fixed Income: Debentures are a fixed income instrument. When a company issues them, it also declares the interest or coupon rate to be received by the investor, which remains fixed for the entire tenure of the debenture except in a few cases.

Low Risk: Debentures involve much less risk than mutual funds and stocks. The companies that issue them are given a credit score by various credit rating agencies on the basis of the risk involved and credibility, which gives an idea of the safety of a debenture and the risk involved in it.

Diversification: You can diversify your equity portfolio by investing in debentures. Being a fixed return, it helps in maintaining your portfolio returns even in adverse market conditions.

Trad-ability: Some debentures can also be traded in the secondary market. Unlike other fixed income instruments where sometimes you have to keep the investment for a lock-in period, you can encash these debentures by trading them on the stock exchange as and when required.

Regular Income: There are both cumulative and non-cumulative options in debenture interest payout. In non-cumulative interest payout, interest is paid to you at monthly or yearly intervals, which can become a good source of regular income.

Disadvantages of Debenture

Interest Rate Risk: Changes in interest rates in the market can affect the value of your invested debentures. If interest increases, the interest rate on your already purchased debentures becomes lower than the current one.

No voting rights: Unlike shares, debenture holders do not have any voting rights in the management and decision making of the company.

Inflation Risk: The interest rate on most debentures is fixed. If inflation rate increases in the economy, then debentures are unable to increase your wealth much in the long term.

Difference Between Bond and Debenture

1. The company can issue debentures for short term or long term as per its requirement, whereas bonds are usually issued for long term.
2. Debentures are mostly issued by private companies, whereas bonds are mainly issued by government agencies, corporations and financial institutions.
3. Higher interest rates are offered in debentures because they are generally not secured and depend on the market reputation of the company. At the same time, the interest rate on bonds is lower and stable than that on debentures.
4. Debentures are more risky than bonds. Before investing in these, you can take help of the rating given to them by the credit rating agency. Bonds are less risky and more secure than debentures.
5. Debentures can be converted partially or completely into equity shares of the company after a period of time but this is not possible in the case of bonds.
6. If in any case the company goes bankrupt, the debenture holder is paid after the bond holder, whereas the bond holder gets priority in payment.

Conclusion

Debentures are an excellent means of raising funds for companies and an excellent means of investment for us. It plays an important role in the Indian financial system through which the flow of capital between the company and the investor is promoted. By investing in debentures, we not only get a good fixed interest rate but we can also diversify our portfolio through it. But here it should also be kept in mind that debentures are generally not secured and the investment made in them completely depends on the creditworthiness of the company. Any company that issues debentures has a rating determined by its credit rating agency, which is very important to keep in mind before investing.