Issue and Redemption of Debentures:
Issue of Debenture refers to the activity of a firm issuing a certificate under its seal in recognition of any debt that the company incurs. The payment of the debenture sum by the firm is referred to as redemption of debentures. Debenture liabilities are discharged when debentures are recovered.
The procedure of issuing debentures is similar to that of issuing shares by a company. A prospectus is issued, applications from interested parties are accepted, and letters of allocation are issued.
If the application is denied, the application fee is repaid, and if the application is only partially accepted, the remaining application fee is utilized in future calls.
Definition of Debenture
A debenture is a debt instrument that serves as a formal agreement between the issuing organization, such as a company or government, and the investors who lend money to the entity. By purchasing debentures, investors essentially become creditors of the issuing entity.
In return, the issuing entity promises to repay the borrowed amount at a specified future date, known as the maturity date, along with periodic interest payments, termed as coupon payments.
Difference between Debentures and Bonds
Debentures and bonds are vital instruments used by entities to raise capital from investors. Though they share certain similarities, they differ in some key aspects. In this comparative analysis, we will present a clear and concise tabular representation of the differences between debentures and bonds, highlighting their unique characteristics and features in a language that is easy to comprehend.
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Difference between Debentures and Bonds
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Criteria
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Debentures
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Bonds
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Definition
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Debentures are long-term debt instruments that represent loans taken from the public.
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Bonds are long-term debt securities issued by governments or corporations.
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Issuer
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Issued by corporations, government entities, and financial institutions.
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Generally issued by large corporations, government agencies, and municipalities.
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Security
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May be secured or unsecured, depending on the terms of the issue.
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Typically secured by specific assets of the issuer to provide greater
investor protection.
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Maturity
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May have fixed or perpetual maturity, Perpetual debentures do not have a maturity date.
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Have a fixed maturity date, after which the principal is repaid to bondholders.
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Interest
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Pay periodic interest known as coupon payments.
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Also, pay periodic interest known as coupon payments.
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Convertibility
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Some debentures may offer the option to convert into equity shares of the issuing company.
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Bonds do not have the option of conversion into equity shares.
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Marketability
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May or may not be actively traded in the secondary market, depending on their
terms.
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Bonds are usually actively traded in the secondary market, providing investors
with liquidity.
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Regulation
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Typically governed by company law and regulations.
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Subject to government regulations and securities exchange rules.
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Characteristics and Features of Debenture
Debentures possess some distinct characteristics and features that differentiate them from other financial instruments:
Unsecured Nature:
Debentures are typically unsecured, which means they are not backed by any specific collateral. Instead, they rely on the general creditworthiness and reputation of the issuing organization.
Fixed Maturity:
Debentures have a predetermined maturity period, commonly ranging from a few years to several decades.
Regular Interest Payments:
The issuing entity pays interest to debenture holders at fixed intervals, often semi-annually or annually.
Transferability:
Debentures are freely transferable, allowing investors to buy or sell them in the secondary market.
Advantages and Disadvantages of Debentures
Debentures are important financial instruments utilized by companies and governments to raise capital from the public. Before considering debentures as an investment option, it is essential to weigh their advantages and disadvantages. Here are a few key points to consider before investing into the debentures:
Advantages:
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Debentures allow companies to raise long-term capital without diluting ownership or giving up control.
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They offer a fixed and predictable source of interest income to investors.
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Convertible debentures provide an option to convert into equity shares, offering the potential for capital appreciation.
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Secured debentures provide investors with additional security through pledged assets.
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Debentures offer flexibility in terms of tenor and interest rate options, catering to diverse investor preferences.
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They are listed on stock exchanges, providing liquidity to investors who wish to sell before maturity.
Disadvantages:
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Debentures may carry higher interest rates compared to other forms of debt instruments, increasing the company's interest burden.
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Non-convertible debentures do not participate in the company's profit-sharing, limiting potential returns.
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In case of default or bankruptcy, debenture holders may face delays or losses in recovering their investments.
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Secured debentures require valuable collateral, tying up assets that could have been used for other purposes.
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Debentures' value may fluctuate with changes in market interest rates, affecting their resale value.
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Companies with significant debenture obligations may face reduced creditworthiness, impacting future borrowing capacity.
Classification and Types of Debentures
Debentures, as financial instruments, can be classified and categorized based on different criteria. In this academic exploration, we will shed light on the various types of debentures, elucidating their characteristics in plain language for better comprehension.
Convertibility Based Classification :
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Convertible Debentures:
These debentures come with an option that allows the holder to convert them into equity shares of the issuing company.
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Non-Convertible Debentures:
Unlike their convertible counterparts, non-convertible debentures do not offer the option to convert into equity shares. Instead, they remain as fixed-income instruments throughout their tenure, providing regular interest payments to investors.
Security Based Classification:
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Secured Debentures:
Secured debentures are backed by specific assets or collateral of the issuing company. In the event of default, the debenture holders have a claim on the pledged assets
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Unsecured Debentures:
Also known as "Naked Debentures," unsecured debentures lack any specific collateral backing
Redemption Based Classification:
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Redeemable Debentures:
Redeemable debentures have a fixed maturity period, and the issuing entity commits to repaying the principal amount at the end of this period
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Irredeemable Debentures (Perpetual Debentures):
Irredeemable debentures, also known as perpetual debentures, do not have a specific maturity date. The issuing entity does not have an obligation to repay the principal amount.
Priority of Repayment Based Classification:
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First Debentures:
First debentures enjoy a higher priority in terms of repayment during liquidation or bankruptcy proceedings. In case of financial distress, these debenture holders are given preference over other debenture holders and shareholders in receiving their dues.
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Second Debentures:
Second debentures rank below first debentures in terms of priority for repayment. They receive their dues only after the first debentures have been fully settled.
Coupon Rate Based Classification:
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Fixed-Rate Debentures:
Fixed-rate debentures come with a predetermined interest rate that remains constant throughout the debenture's tenure.
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Floating-Rate Debentures:
Floating-rate debentures, on the other hand, have an interest rate that fluctuates based on a benchmark interest rate, such as the prevailing market rate or a specified index.
Currency Based Classification:
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Domestic Debentures:
Domestic debentures are issued in the local currency of the country where the issuing entity operates
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Foreign Currency Debentures:
Foreign currency debentures are issued in a currency other than the local currency of the issuing entity's home country.
Registration Based Classification:
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Registered Debentures:
Registered debentures are issued in the name of the specific investor, and the issuing company maintains a record of the debenture holders.
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Bearer Debentures:
Bearer debentures, on the other hand, are not registered in the name of a particular investor. Instead, they are negotiable instruments that can be transferred by mere delivery.
Marketability Based Classification:
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Marketable Debentures:
Marketable debentures are actively traded in the secondary market, allowing investors to buy and sell them before their maturity date.
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Non-Marketable Debentures:
Non-marketable debentures, also known as private placements, are not traded in the secondary market
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Laws and Regulations Governing Debentures
Understanding the laws governing debentures is crucial for both issuing companies and debenture holders. These laws, implemented by regulatory authorities, aim to promote transparency, investor confidence, and the orderly functioning of the financial markets. Given below are a few laws and regulations governing the debentures:
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Company Law
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Securities and Exchange Board of India (SEBI) Regulations
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Companies Act, 2013
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Securities Contracts (Regulation) Act, 1956
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Reserve Bank of India (RBI) Guidelines
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Foreign Exchange Management Act (FEMA
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Income Tax Act, 1961
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Listing Agreement and Stock Exchange Rules
