Difference between Convertible and Non-convertible debentures

Convertible and Non-convertible debentures: In corporate finance, companies have many strategies for raising capital. One such avenue is issuing bonds on the open market, offering an alternative to traditional bank borrowing. Bonds, categorised as debt instruments, enable businesses to secure funds directly from investors, bypassing the intermediary role of financial institutions. Similarly, understanding the nuances between various fixed-income securities is crucial for informed decision-making in investment. Convertible and non-convertible debentures represent two distinct types of debt instruments corporations utilise to raise capital, each carrying its features and implications for investors.

What is Convertible Debenture?

• Debt Instruments Repayment : Fixed-income instruments, including bonds or loans, are responsible for repaying the underlying debt. When a company amasses excessive debt, it becomes liable for high debt-servicing costs and interest payments. Consequently, companies burdened with significant debt often face earnings volatility.
• Equity Characteristics : Equity, in contrast, does not entail the necessity of repayment or the obligation to pay interest to holders. However, companies may distribute dividends to shareholders, potentially diminishing retained earnings or accumulated profits.
• Convertible Debentures as Hybrid Instruments : Convertible debentures are designed as hybrid products that seek to balance debt and equity characteristics. Investors benefit from fixed interest payments while retaining the flexibility to convert the loan into equity, especially if the company's performance drives up stock prices.
• Investor Risks and Protections : Investors who hold shares of common stock assume higher risks, as there is typically limited insurance available in the event of default. However, in bankruptcy liquidation proceedings, holders of convertible debentures are given priority over common shareholders. This prioritisation offers a degree of protection to investors, ensuring they receive payment before common shareholders during liquidation.

What is Non-Convertible Debenture?

The Advantages of Nonconvertible Debentures

• Lower Risk : The fixed interest rate, predetermined maturity period, and the issuer's creditworthiness assessed by rating agencies like CRISIL, ICRA, and CARE mitigate investor risk associated with NCDs.
• Higher Liquidity : NCDs exhibit higher liquidity as they can be traded on the secondary market anytime. Mandatory listing on a stock exchange facilitates easy trading, allowing holders requiring immediate cash to sell their holdings effortlessly.
• Higher Returns than Some Other Fixed-Income Instruments : NCDs typically offer superior interest rates to bank Fixed Deposits (FDs). They also provide repayment flexibility, with monthly, quarterly, half-yearly, or annual payout options. Some issuers may even offer a cumulative payout option.
• Possibility of Default : While NCDs, like all debentures, rely on the issuer's creditworthiness, the likelihood of issuer default is generally low, barring unforeseen circumstances. Consequently, investors usually receive expected returns and regain their principal upon maturity.

Difference Between Convertible and Non-convertible debentures

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