Debentures Overview

Debentures

Debentures are long-term debt instruments issued by governments and corporations to meet their financial requirements. They are an unsecured form of borrowing from the public with a lengthy tenure, usually exceeding ten years. Debentures are not backed by physical assets or collateral, and the issuer pays a fixed interest at a coupon rate at regular intervals to compensate the investor.

Meaning

Debentures are a type of debt instrument that allows investors to lend money to a corporation or government. They are typically unsecured, meaning they do not have a specific asset backing them, and the interest rate is fixed at the time of issuance.

Types

There are different types of debentures, including:

• Secured Debentures: Issued against a security or collateral.
• Unsecured Debentures: Issued without any charge against the issuing company’s assets.
• Redeemable Debentures: Repaid at the end of a certain period.
• Irredeemable Debentures: Not redeemed or repaid during the lifetime of the company.
• Convertible Debentures: Convertible into equity shares of the issuing company.

Debentures can be issued by both public and private companies, although the methods of issuance differ. Public companies can issue debentures through the public market, while private companies typically issue debentures through private placements.

Features

• Long-term: Debentures have a long-term tenure, typically exceeding ten years.
• Unsecured: They do not have a specific asset backing them.
• Interest: The issuer pays a fixed interest at a coupon rate at regular intervals.
• Redeemable: Debentures can be redeemed at the end of the tenure or in installments.
• Transferable: They can be bought and sold in the open market, providing greater liquidity.

Advantages

• Fixed Income: Debentures provide a fixed rate of interest, which is beneficial for investors.
• Lower Risk: The risk is lower than with equity shares, as investors do not have voting rights in the company.
• Cheaper Source of Funds: The flotation costs and listing costs for debentures are lower than those of equity capital, making them a cheaper source of funds.

Disadvantages

• No Voting Rights: Debenture holders do not have voting rights in the company, which can be a disadvantage for those who want to participate in company decisions.
• Interest Payment Rigidity: The issuer must pay interest regardless of the company's profit situation.
• Less Control over Assets: Assets against which charges are made cannot be employed freely for the company's uses because they are under the control of the debenture holders.

Debenture Redemption Reserve (DRR)

In India, companies issuing debentures must create a debenture redemption reserve (DRR) to protect investors from the possibility of a default by the issuing company. The DRR requirement is to safeguard the interests of debenture holders, as debentures are not backed by collateral or security. The reserve must represent at least 10% of the face value of debentures issued.

Conclusion

Debentures are an important tool for governments and corporations to raise long-term funds through the public market. They offer fixed income, lower risk, and a cheaper source of funds compared to equity shares. However, they also come with some disadvantages, such as no voting rights and interest payment rigidity.