Types of Debentures

Types of Debentures

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Rashmi
Rashmi Karan
Manager - Content
Updated on Feb 13, 2024 10:45 IST

If you want to diversify your investment portfolio without having to leave fixed income, it is worth knowing the different types of debentures. This type of security may yield better than alternatives of the same investment class. However, to invest properly, it is necessary to understand what types of debentures exist and their advantages and risks. After all, without being clear about these aspects, you can make wrong decisions when making your investments.

Are you interested in these investment alternatives? So keep reading this article and check out the different debentures you need to know about.

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Content 

What is Debenture?

Debentures are fixed-income investments issued by companies and traded on the capital market. These investments are like loans the investor makes to companies that return the money with interest.

The purpose of a debenture is to raise funds for non-financial companies. This is a more agile way to get money, as well as is cheaper than asking for a loan from the bank.

Therefore, the company “sells” a part of its debt in exchange for interest payments. Following the rules of each type of debenture, the investor redeems the investment together with the earnings.

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Although debentures are traded on the capital market, this type of investment differs from shares acquired on the stock exchange.

When an investor chooses to invest in a debenture, he does not become a shareholder but the company creditor. Now that you know what is debenture, let us move on to their use.

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Use of Debentures

Debentures are issued to raise funds from the public. The issuing firm uses these funds for its expansion and growth, R&D activities, etc. 

Issuance of debentures is a preferred choice among financial institutions for two reasons.

  1. Issuing debentures does not lead to the dilution of ownership dilution. 
  2. The cost of raising funds through debenture is cheaper than the cost of raising funds through equity shares.  
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Types of Debentures

Here are some of the most common types of debentures:

Convertible Debentures

The investors’ debenture holdings can convert these types of debenture into equity shares of the company. At the time of the issuance of the convertible debentures, the rights of the debenture holders, the trigger date for conversion, and the conversion date are mentioned.

However, this exchange has specific rules, such as the bond and stock price conversion. 

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Non-Convertible Debentures

The investors cannot convert the non-convertible debentures into equity shares. So, when choosing this type of asset, the investor will always be remunerated according to the pre-, post-fixed, or hybrid profitability.

Registered Debentures

The details of registered debenture holders are registered in the company’s records. Suppose a debenture holder wants to change the ownership of such debentures. In that case, the transfer or trading must be organized through a clearing facility, which then alerts the issuer about the changes in ownership so that the interest can be paid to the right bondholder.

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Unregistered Debentures

Such debentures are also called bearer debentures. These debentures are issued by a company that does not require its holders to maintain records. In the case of unregistered debentures, the company pays the principal amount and the debenture’s bearer, irrespective of its name. Unregistered debentures are easily transferable. 

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Redeemable Debentures

These debentures are redeemable as per the mentioned redeemable date on the company’s debenture certificate. Once the redemption date arrives, the company is bound to return the principal amount to the debenture holder. 

Irredeemable Debentures

As the name suggests, irredeemable debentures are the opposite of redeemable debentures and have no fixed date for the debenture holder’s payment. These are only redeemable when the company goes through liquidation.

Incentivized Debentures

Also called infrastructure debentures, these bonds are issued by businesses that carry out strategic activities for the country’s development. 

Usually, they are from priority sectors such as logistics, transport, basic sanitation, and energy. A significant benefit of incentivized debentures is that they are tax-exempted.

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Features of Debentures

Debentures are a popular choice with some exciting features, which include the following – 

  • They are the preferred investment option since, in debentures, the returns are determined with a fixed rate of income.
  • If you hold the debentures of any company, that does not make you its owner or partner. Debenture holders do not have the right to vote to control the management of the issuing firm. However, in the event of defaults, the debenture holders can take legal steps against the firm.
  • Debentures come with a better return on investments than shares.
  • If the issuing firm liquifies, debenture holders get preference when the borrowed amount is being repaid.
  • The company is bound to return the obligations at the agreed-upon interest rate to the debenture holders, regardless of profits or loss.

How Is a Debenture Different From a Bond?

A debenture is a type of bond. More specifically, it is an unsecured or non-collateralized debt issued by any entity. It refers to such bonds with longer maturities. 

Secured bonds are backed by collateral in the form of property, securities, or other assets, which can be seized to repay creditors in case of default. On the other hand, unsecured debentures have no such collateralization. Thus, they are relatively riskier.

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Debentures Guarantees

Unlike fixed-income investments, such as CDBs, debentures do not have the Credit Guarantee Fund (FGC). 

The main risk of a debenture is the “default” of the company that issued the bond. The company does not pay investors due to bankruptcy or other problems. Therefore, it is necessary to analyze how the company is in the market.

Therefore, they offer other types of guarantees, such as:

Real guarantee: The issuing company makes its assets or third-party assets available to be sold, thus paying off debts with investors. While under warranty, these items are non-tradable;

Floating guarantee: products are also offered to guarantee payment. However, they can be traded or replaced by the enterprise;

Subordinated guarantee: Here, investors are given preference in receiving the money in case the company goes bankrupt. So they get on the pay list before shareholders;

Unsecured guarantee or guarantee without preference: The buyer does not have priority in receiving and is under the same conditions as any company creditor.

Why Invest in Debentures?

Investing in debentures can be a good option for those who want to achieve a higher yield than in other fixed-income investments. This is because debentures usually have higher remuneration.

Those who invest in debentures also have the chance to diversify their investments. A broad portfolio can maximize gains, reduce risks and provide several alternatives for liquidity. Therefore, having some of the types of debentures among its applications brings diversification, which is essential for every investor. 


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FAQs - Types of Debentures

What are the advantages of investing in debentures?

Investing in debentures can provide investors with a steady stream of fixed income through regular interest payments. Additionally, depending on the type of debenture, investors may benefit from potential capital appreciation or conversion into equity shares.

What risks should I consider when investing in debentures?

Risks associated with debentures include credit risk (the risk of the issuer defaulting on payments), interest rate risk (the risk of fluctuations in interest rates affecting the value of the debenture), and liquidity risk (the risk of not being able to sell the debenture quickly at fair market value).

How do I assess the creditworthiness of a company issuing debentures?

Investors can evaluate a company's creditworthiness by examining its credit rating provided by rating agencies, analyzing its financial statements, assessing its industry position and competitive advantages, and reviewing its track record of debt repayment.

What factors should investors consider when investing in debentures?

Investors should consider factors such as the credit rating of the issuing company, the interest rate offered, the type of debenture (convertible or non-convertible), the tenure of the debenture, and the company's financial health and repayment history.

How can investors buy debentures?

Investors can buy debentures through public offerings, private placements, or secondary markets like stock exchanges. They can also invest in debenture mutual funds, which pool money from multiple investors to invest in a diversified portfolio of debentures.

About the Author
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Rashmi Karan
Manager - Content

Rashmi is a postgraduate in Biotechnology with a flair for research-oriented work and has an experience of over 13 years in content creation and social media handling. She has a diversified writing portfolio and aim... Read Full Bio