Debentures - The Debt Instruments

Posted in Finance Articles, Total Reads: 10745 , Published on February 27, 2011

In the financial world, investors are usually on the lookout of regular fixed income on their investments. Here in this article we would try to analyze one such commonly heard fixed income instrument by the name Debenture. Often in the newspapers we can see the terms debentures and bonds used in the same context. So what exactly do these two terms mean. They are basically fixed income instruments used by the borrowers who wish to raise capital for the business purposes.


So does that mean both are the same? The answer is actually NO. 
Debentures and bonds are debt instrument but have varying profile of risks associated with them. Bondholders have security in the form of underlying assets incase there is any default on the part of the issuer. However in the case of debentures, they are unsecured and have no access to the assets of the issuer. They are backed only by the creditworthiness and reputation of the issuer. Yet another difference happens to be the fluctuation of the bond value depending on the market interest rates whereas the debentures are usually not traded.
To understand the concept better let us see how it actually works. A Company X wants to raise Rs 100 Cr in the form of bonds. If the company is willing to pledge Rs 100 Cr worth of its assets to the bondholder it provides cushion to its borrowers that they would be repaid in case of default. Thus bonds are referred to as asset backed or securitized. However let us assume that the same company is extremely credit worthy, and then pledging its assets may not be necessary to attract investors. In this case they could issue debentures and the debenture holders would have claim to the assets of the company which is not pledged to the bondholders.
So if both the bonds and debentures are almost similar why do people have to invest in debentures which carry a higher risk profile as compared to bonds. The reason lies in the higher interest rate offered on debentures to reflect the higher risk attached to it.
Now like in a share or a bond market, when the debenture by corporate it could be issued at a premium or at a discount. So if the debenture is issued at a price more than their nominal price, then it is said that it is issued at a premium. But if the debenture is issued at a price lower than its nominal price, then it is said that it is issued at a discount.
Like in the bond markets where we have bonds of different types similar is the case with the debentures as well. They also come in different flavours and some of the commonly heard types of debentures are listed below : 

a) Secured or mortgage debentures: As the same suggests these types of debentures are secured by the assets of the company. The holders of secured debentures have the right to recover their principal amount with the unpaid amount of interest on such debentures out of the assets mortgaged by the company.
b) Redeemable Debentures: These types of debentures are issued for a certain period and the principal amount has to be returned to the debenture holder upon the expiry of the period.
c) Non-redeemable Debentures:  During the lifetime of the company these debentures are not repaid and the debenture holder received his money only upon the liquidation of the company.
d) Registered Debentures: These debentures are registered with the company and the amount is repayable only to the one whose name appears in the register of the company.
e) Bearer Debentures: These debentures are not registered with the company but the debenture holder is entitled to receive interest on the principal amount.
f) Convertible Debentures: These are the type of debentures which can be converted into the shares of the company upon the expiry of certain period upon the non fulfillment of certain conditions set during the issue of such debentures.
g) Non-convertible Debentures: As the name suggests it cannot be converted into the shares of the company upon the expiry of the debenture period.
So basically debentures are another type of fixed income financial instrument used by the corporates to raise capital for their business process.

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