What are Debentures and what are its types?

Debentures are a type of Debt Instrument or Bond which are a type of Debt instrument issued by Companies and Governments without any substantial collateral against the Debentures or Loans issued. These are issued mostly to Corporate.

In short, Debentures are a type of Unsecured Loans that Institutions and Governments issue to raise capital and money without taking any Loans from a Financial Institution. These Debentures have a fixed tenure and a fixed rate of Interest which is received by the Debenture holders, paid by the issuer.

Bond vs. Debentures: Basic Difference

Bond and Debentures are somewhat similar in many fields like the Interest rate, par Value, etc but there are some difference as well, they are mentioned below-

1. Bonds are generally issued by Governments but Debentures can be issued by any corporate entity or Company.

2. Bonds have collateral or are backed by some assets but debentures are like an Unsecured Loan that is not backed by any assets.

3. The risk factor on Debentures is high comparing it Bonds ass the chances of Default is higher as the Loan is unsecured and in the case, the Issuer of the Debenture goes Bankrupt then the investors do not have the right to claim on any assets of the company, whereas in the case of Bonds if the company goes bankrupt then the assets can be sold and paid off the Bondholders.

4. The Interest on Debentures is higher than Bonds as the Investor is taking more Risks than that of Bonds.

5. Bonds cannot be converted into Equity but in the case of Convertible Debentures, the investor can choose to get their debentures converted into Equity shares at the time of Maturity.

Types of Debentures

There are 5 categories of Dentures-

1.Secured & Unsecured Debentures

2. Convertible & Non-Convertible Debentures

3. Redeemable & Irredeemable Debentures

4. Registered & Bearer Debentures

5. First & Second Debentures

1.Secured & Unsecured Debentures

Secured Debentures are Debentures behind which some Assets are attached of the Issuer company so that if the company goes bankrupt then those assets can be sold to pay the Debenture Holders. On the other hand, Unsecured Debentures are those types of debentures where no assets or collateral is attached.

2.Convertible & Non-Convertible Debentures

Convertible debentures are those type of Debentures which can be converted into equity shares of the issuing company. The Holder of a Convertible Debenture has the option to hold on to the Bond till the maturity date and get the periodic interest or get the bond converted into Equity shares before the Maturity date. Non-Convertible debentures are normal Debentures where the holder does not have the option to convert the Bond into Equity shares. Due to this disadvantage, Non-Convertible Debentures or NCDs have a higher Interest rate than convertible debentures.

3.Redeemable & Irredeemable Debentures

Redeemable debentures are the Debentures that have a maturity date on which the Issuer of the Debentures repays beck the principal amount to the Bod holder. In the case of Irredeemable Debentures, there is no Maturity date on which the Debentures are repaid. The interest if the Debentures are paid regularly. These Debentures are only at the time of the dissolution of the company or when the company decides to repay them.

4.Registered & Bearer Debentures

The holder of every Registered Debenture is recorded in the company’s books hence one cannot sell or transfer a Registered Debentures to anyone without the sanction of the directors of the company. Registered Debentures are also Non-negotiable due to this nature. Bearer Debentures are those type of debentures which can be held and transferred without any obstruction of the company as the holder of these debentures is not recorded by the company.

5.First & Second Debentures

First & Second debentures are mostly similar to one another in features but they have only one major difference which is, First debentures have a preference of repayment from the assets in the event of liquidation over any other debentures. First Debentures are repaid first before any other debentures. After all the First Debenture holders are paid, the Second debenture holders are paid.

Debentures

Debentures can be of many types but the most common ones are Non-convertible debentures and Bearer Debentures. Earlier only banks and other financial institutions were allowed to purchase Debentures but now Retail Investors with capital are allowed to buy Debentures.

Debentures are considered a good investment for Fixed Income investors who look for steady cash flow from their investments. Debentures are a good option for them as they give a higher rate of return than Bonds.