Finance

Debentures and Its Types

Debentures and Its Types

It is a long-term debt certificate issued by companies and governments to secure new money and capital. The overall credit and reputation of the issuer are sufficient, so no collateral or physical assets are required to support the debt. A coupon or interest rate is offered as compensation to the lender. Examples of government-issued debentures are treasury bonds and treasury bills. These are considered risk-free as the government can refund the unpaid amount and collect from the resource tax. Corporate debentures are most commonly used for long-term loans, which have a fixed date for repayment as well as a fixed interest rate.

 

What are the Different Types of Debenture?

There are two main types of debentures that can be issued:

#1 Convertible debentures: Interest-bearing bonds that can be converted from debt into equity shares after a specific period of time. This is a special feature that corporations take advantage of because it can attract lenders and usually carries a lower interest rate for the issuing company.

#2 Non-convertible debentures: Regular debt instruments that are not convertible into equity shares. However, to attract lenders and investors, these come with higher interest rates.

Before investing in debentures, investors or lenders need to weigh these vital points:

#1 Credit rating: There are various agencies that assess credit ratings in order to gauge the quality of a bond in terms of credit performance. A high rating of AAA or AAA+ is preferred.

What are the Different Types of Debenture?
#2 Coupon rate:
This is the interest rate offered by the issuer. A higher rate implies higher risk debt instruments, and a lower rate means lower risk debt instruments. Coupon payments can be made monthly, quarterly, semiannually, or annually.

#3 Issuer’s credibility: The financial health of the company or issuer is still the best assessment of creditworthiness. Knowing why additional money/capital is needed as well as credit are the most important factors in making an investment decision.

#4 Additional benefits or features: These are special features added to promote a product or attract investors, some of which are given to A-listers, who have a significant financial position in the company. Companies can offer a profit-sharing plan to employees as a form of commitment.

 

What are the pros and cons of a debenture?

There are two important considerations to consider when evaluating the pros and cons:

#1 The issuer:

From the issuer's point of view, convertible bonds can be viewed as advantageous because they can be offered with a lower coupon than that of bonds. Bond interest is also a deductible expense of the issuing company and is taxed less than the issued capital. Holders of convertible bonds can only receive a limited fixed income until they convert, no matter how much profit the company makes. In other words, a company can only share operating profits when things are going well.

#2 Investors:

For investors or lenders, convertible bonds provide a safe asset, especially for those who want to participate in the company's potential growth. When bonds are converted into shares, investors or lenders can take advantage of the increased market value of the shares. Although riskier than convertible bonds in terms of market volatility, convertible bonds offer higher interest rates or returns to bond holders. However, when interest rates rise, the value of bonds decreases. Since it cannot be converted into shares, your only option is to wait until the maturity period.

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