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Debentures are debt
instruments issued by a joint stock company. Amounts collected
by way of debentures form part of the loan capital of a company.
They are repayable after a fixed period. Debentures are issued
in units of small value for convenient buying and selling.
Debenture holders get interest on their debentures. They are
creditors of the company. They do not get dividend. Only
shareholders get dividend.
According to S.2
(12) of the companies Act, 1956, debentures include “debenture
stock, bonds and any other securities of a company”. The basic
difference between debentures and bonds is that the debentures
are usually secured. Unlike debentures bonds can be floated with
a fixed interest or floating interest rate. They can also be
issued without interest as discount bonds. Discount bonds are
issued at a discount on the face value. The investor gets full
amount on redemption of debenture. From the point of view of
investor, bonds are instruments carrying higher risks and higher
rates of returns compared to debentures.
The characteristics
of debentures can be summarised as follows:
Debentures are debt
instruments.
They generally
carry fixed rate of interest.
They are normally
repayable at the end of a fixed period. Repayment of debenture
or cancellation of debenture liability in the books of the
company is known as redemption of debentures.
They can be issued
at par, premium or at discount depending on the reputation of
the company.
They can either be
placed privately or offered for public subscription.
They may or may not
be listed in the stock exchange.
If offered for
public subscription, they should be rated by a credit rating
agency approved by SEBI, prior to listing.
Interest is payable
on debentures at a fixed rate irrespective of the profit earned
by the business.
Debentures may be
issued with or without the security of assets of the company.
In the event of
winding up of the company the debenture holders are treated as
creditors and given priority in repayment of their money.
Debenture holders
normally do not have representation in the Board of the company.
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Shares |
Debentures |
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Shares
represent the ownership of the company
Share
holders are paid dividend only if the company makes
profit
Dividend is
usually paid once a year
There is no
fixed rate of dividend on shares.
Directors
are elected by shareholders and thus the shareholders
participate in the management through representatives
Shares are
permanent (except redeemable preference shares)
Shares are
not issued on the security of any asset of the company
In the
event of winding up of the company, share holders get
their payment at the end, only after all other claims
are settled. |
Debentures
represent the loan of the company
Debenture
holders are paid interest at the fixed rate irrespective
of profit
Interest on
debenture is usually paid in six months
Interest on
debenture is paid at a fixed rate
Debenture
holders are allowed to have their representatives in the
Board only under special circumstances
Debentures
are repayable at the end of a fixed period and failure
to repay the debentures on due date can cause
disqualification of directors.
Debentures
can be issued on the security of any specific asset or
with a general charge on all the assets of the company.
Secured
debentures get priority over all the normal creditors.
Unsecured debentures are listed with other creditors and
settled prior to any payment to shareholders. |
Debentures are
classified as follows:
1. On the Basis of Repayment
a. Redeemable Debentures
These debentures
are paid off or redeemed after the prescribed period.
b. Irredeemable or Perpetual Debentures
These debentures
are permanent debentures of a company. They are paid back only
in the event of winding up of a company.
2. On the Basis of Transferability
a. Registered Debentures
These are
debentures for which the company maintains record of debenture
holders. Therefore when such debentures are sold or transferred
it should be intimated to the company for making change in the
register of debenture holders.
b. Bearer Debentures
These debentures
are transferable by mere delivery. There is no need or
registration of transfer with the company.
3. On the Basis of Security
a. Simple or Naked Debentures
These are
debentures not secured by any asset of the company. If the
company goes into liquidation these debentures are treated as
unsecured creditors.
b. Mortgage Debentures
Mortgage debentures
are issued on the security of certain assets of the company.
They can be secured by fixed assets or floating assets of the
company. If the debentures are secured by a fixed charge on
assets, the company cannot sell or exchange the assets without
paying off the debentures. However in case of floating charge,
the company can buy or sell the assets involved until the
winding up procedures are initiated or the debenture holders
exercise their right to ‘crystallise’ the claim.
4. On the basis of Conversion
a. Convertible
Debentures
These debentures
are issued with an option to debenture holders to convert them
into shares after a fixed period. Convertible debentures are
either partially convertible debentures or fully
convertible debentures. In case of partially convertible
debentures part of the instrument is redeemed and part of it is
converted into shares.
In case of fully
convertible debentures the full value of the debenture is
converted into equity. Convertible debentures are generally
issued to prevent sudden outflow of the capital at the time of
maturity of the instrument, which may cause liquidity problems.
The conversion ratio, which is the number of equity
shares exchanged per unit of the convertible debenture is
clearly stated when the instrument is issued.
b. Non Convertible Debentures
These are
debentures issued without conversion option. The total amount of
the debenture will be redeemed by the issuing company at the end
of the specific period.
5.
On the Basis of Pre-Mature Redemption Rights:
a. Debenture
with “Call” option
A callable
debenture is one in which the issuing company has the option of
redeeming the security before the specified redemption date at a
pre-determined price.
b. Debenture
with “Put” option
This is a debenture
in which the holder has the option of getting it redeemed before
maturity.
6.
On the Basis of Coupon Rate (interest rate)
a. Fixed Rate
Debentures
Most of the time
debentures are issued with a prefixed rate interest. These
debentures are called fixed interest debentures
b. Floating rate
Debentures
Floating rate as
the names suggests keeps changing. It is usually linked with PLR
(prime lending rate). It may add a risk premium to PLR on
debenture. Thus PLR + 50 “basis points” and if the PLR is 11
percent, debenture interest rate will be 11.5 percent.
c. Zero Coupon
Bonds
These are
debentures issued with no interest specified. They are issued at
a substantial discount to compensate the investors. These bonds
are known as deep discount bonds. The difference between
the face value and the issue price is the total amount of
interest for the duration of the bond. From the account point of
view this discount is recorded as “Deferred Interest Expense
Account” at the time of issue bonds and proportionate amounts
are written off each year over the life of the bond.
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