The Debentures Story ...

There are ways through which a company can raise funds from general public. The most popular methods are via issuance of IPO or right shares. Today, we will discuss of the other option that is gaining momentum now. i.e. through issue of debentures. It is simpler for company and also the cost of raising funds through debentures is lower than equity. 

What is a Debenture?

Debenture is a debt instrument. It is similar to a loan taken by the issuer (mostly corporate) to raise money without parting with their company ownership). The general features of any debenture are as follows:

a) Fixed interest rate and fixed tenure.

b) It is useful to raise debt for medium and long term.

c)  It can be secured against assets or any collateral. The most popular debentures are unsecured and thus, have lower interest rates over long term bonds issued by government.

d) The debenture holders don’t have any say in the company management. i.e. they don’t any voting power.

e) There are debentures that can be transferred in the secondary market. However, this market is usually illiquid for trading.

Types of Debentures

The debenture are divided based on their term, redemption, underlying security or asset, transferability or tradability, interest rate, coupon rate, etc.

    

     a)   Convertible Or Non Convertible Debentures

The Convertible Debentures can be converted into equity shares at a later date. Thus, as a unit holder it gives the holder chance to become the share holder in the particular company. Usually, the convertible debentures have lower interest rates as compared to Non convertible debentures. The debenture may be partly also convertible. The ratio is pre defined at the time of subscription. In India, most of the debentures issued are Non Convertible Debentures.

    b)   Redeemable or Non Redeemable Debentures

Redeemable debentures are issued for fixed period of time. It is returned to customers at the end of tenure. Non redeemable debentures are only redeemed at the time of dissolution of company. In India, all the debentures are redeemable in nature.

    c)   Secured or Unsecured Debentures

The debentures can be secured or backed by the company assets to fulfil its obligations. They can also be further clubbed with “call” or “Put” options. The call options lets the company call back the debentures before maturity in case if it has issued high interest rate for its NCD and there is fall in interest markets. The Put option is exactly opposite and is exercised by the investor.

The debenture selection depends upon the credit rating of the debenture issued by the credit companies. The interest rate given by high risk debentures is also high. (Debentures are at risk of default.) Also the coupon rate and payout mode determines the selection. One of the important criteria to determine the selection is past performance of the issuer company.

Taxation of debentures

TDS is applicable on interest earned on dematerialised debentures. If the debentures are not dematerialised then they are subject to be taxed at personal tax slab rates for short term. i.e. upto 3 years of holding. Beyond 3 years, the capital gains would be subject to indexation similar to any other debt product.  

Regards

Saarthi Financial Planners