Debenture – the safest way to Invest in Market
Debenture as its name suggests it is a type of Debt that companies or government take from the investors. The word is taken from the Latin word ‘debere’ which means to borrow or loan. So, it is like a written monetary contract between the Government/ Firm and the person lending the loan, so it is somewhat like a loan certificate.
Need for Debenture products
When any company wants to expand its business they are in need of funds and Funds can be raised by Equity/ Stocks or Debt. So here we will discuss the Debenture and Equity part that will be discussed in another blog.
What is Debenture
It is a medium- to the long-term tool by which companies can borrow money from the investors with a contract of pat back at a fixed rate of interest in a pre-decided time frame. So it is a paper that clearly certifies that a particular company taking a loan from the investor is liable to pay back the money with a fixed rate of interest and in limited time. A Debt is different from the Share capital, as by borrowing loan from Investors, The company is in contract to pay back but the investor does not become part of their share.
So in nutshell Debt is:
⇒ Issued by Government and Private Firms both.
⇒ Generally, long term Debt is issued by Government while Short term one is issued by both.
⇒ A movable property i.e. holder can transfer his ownership freely to anyone on his/her will and company has no say in it.
⇒ It is a certificate of loan which has a fixed rate of interest and to be paid timely mentioned in the contract itself.
⇒ The person purchasing Debt has no voting rights in the meetings of the company as he is not a part of the share capital of the company.
Advantages of Debentures
⇒ The biggest advantage of it is for the firm where the company has no need to change in its equity as Debt holder is not a part of their share capital.
⇒ It provides an opportunity for investors for long term planning for their personal finances.
⇒ It is usually cheap in purchasing.
⇒ It also helps in tax planning for an Individual as It is generally tax-free.
⇒ It is the safest way to invest money in firms by any investor.
⇒ In the case of market crash and trembling of stocks of the company, Debenture holder will be paid first when the asset of the company is sold.
Types of Debentures
Debenture issued by the Government/ Firms are classified into various types depending on the Security, tenure, on convertibility option, etc and so different types are like these:
These are types that are secured against an asset/ of the company. If the company fails to repay the Debt payment to the investor because of the non-availability of the fund with a company than the same will be made after selling the assets of the company.
These are not secured by any charge against the assets of the company and this type of Debenture are generally not issued in India.
Company is liable to pay the amount plus fixed rate of interest to the investor after a pre specifies time frame i.e. it can be redeemed when the time frame has lapsed.
This type is not redeemable after a specific period of time and can be redeemed only when the company gets its liquidation or at the time of the dissolution of the company. This type of Debenture is also not issued in India and the maximum period of any Debenture issued in India is for 20 Years.
Fully Convertible Debentures:
In this type, an option is available with the investor whether he wants to redeem his investment or else again want to reinvest. If he chooses the second option then, redeemed units will be converted into the Shares of the company at a current price so by this he can become a shareholder of the company.
Partly Convertible Debentures:
In this type, a portion of his investment will be converted to the shares of the company. The remaining portion of his purchase will continue to act as Debenture only. So, in this way, Investors can be both Creditors and Shareholders to the company at the same time.
This is the most common type and here no option lies with an investor to convert his redeemed debenture into share either partially or fully.
Bond v/s Debenture
both are the ways to raise funds by the Government and companies from the investors with a monetary contract to repay the investor with a fixed rate of interest. So technically both are the same in a way but if we go into details then we can find some differences among them. As a Debenture, you give an unsecured loan to the company while in terms of Bond you are giving a Secure loan to the company which is secured against the physical assets of the company.
⇒Bonds are more secure than Debts as it is an unsecured loan
⇒Rate of Interest is less in terms of Bonds as compared with Debts
⇒If there is any case of fraud by a company then Bondholder will be paid first and then the turn comes for Debt Holders
⇒Debenture holder gets his/her Interest paid periodically to them termed ad coupon and the principal amount back after a specified interval.
⇒Bondholders did not receive any periodical interest and get paid with all dues only after completion of tenure.
⇒ Debt part is more risky while Bonds are less risky.
⇒ A bond can not be converted into equity shares while Debt can be easily transferred to equity funds.
⇒ Bonds can be considered as long term investment whereas tenure of Debt totally depends on the organizations issuing it.
⇒ Bonds can be issued by both Public/Private Organisations whereas Debenture is generally issued by private bodies.
Nowadays there many schemes from the Mutual Fund companies through which you can invest in these so-called secured modes of investment and the process is hassle-free. But before start investing, it is advised to go through some basics of investment and personal finance so that it will help you get some insight into the world of wealth creation.
SEBI (Security Exchange Board of India) is the regulator of the commodity and security market in India and all the Mutual Fund must be registered with SEBI. SEBI can be visited through its Official website and It keeps an eye on the performance and default and accordingly provide guidance to the houses for the sake of consumers.