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Debenture, types and advantages

INDEX

Definition Debentures Types of debenture The Advantages And Disadvantages Of Debentures for investors Advantages & Disadvantages for the Issuing Institution

Definition Debentures The Definition Debentures or the Definition of Debentures can be given in many ways. A Debenture is a Debt Instrument, which is not backed by Collaterals. Debentures are backed by the creditworthiness and reputation of the Debenture issuer. Collaterals: Collaterals are assets or properties which are provided to secure a loan or any other type of credit. If there is a default, Collateral is a subject of seizure. Collateral is a type of security provided to the lender if there is a default on behalf of the borrower in repayment of loan. For instance, if a person takes a mortgage loan, the Collateral would be his house. A Debenture is a long-term Debt Instrument issued by governments and big institutions for the purpose of raising funds. The Debenture has some similarities with Bonds but the terms and conditions of securitization of Debentures are different from that of a Bond. A Debenture is regarded as an unsecured investment because there are no pledges (guarantee) or liens available on particular assets. Nonetheless, a Debenture is backed by all the assets which have not been pledged otherwise. Normally, Debentures are referred to as freely negotiable Debt Instruments. The Debenture holder functions as a lender to the issuer of the Debenture. In return, a specific rate of interest is paid to the Debenture holder by the Debenture issuer similar to the case of a loan. In practice, the differentiation between a Debenture and a Bond is not observed every time. In some cases, Bonds are also termed as Debentures and vice-versa. If a bankruptcy occurs, Debenture holders are treated as general creditors. The Debenture issuer has a substantial advantage from issuing a Debenture because the particular assets are kept without any encumbrances so that the option is open for issuing them in future for financing purposes.

Types of debenture Convertible Debentures: This is a debenture which can be converted into some other type of securities (for example stocks). Corporate Debentures: Corporate Debentures are Debentures issued by companies and they are insecure in nature. Bank Debentures: These types of Debentures are issued by banks. Government Debentures: These include Treasury Bonds (T-Bond) and Treasury Bills (T-Bill) issued by the government. They are usually regarded as risk-free investments. Subordinated Debentures: This is a particular type of Debenture, which ranks below regular Debentures, senior debt, and in some instances below specific general creditors. Corporation Debentures: Corporation Debentures are issued by various corporations. Exchangeable Debentures: They are like Convertible Debentures, but this Debenture can only be converted to the common stock of a subsidiary company or affiliated company of the Debenture issuer. Debentures can be classified on the basis of convertibility into: Non Convertible Debentures (NCD): These instruments retain the debt character and can not be converted in to equity shares Partly Convertible Debentures (PCD): A part of these instruments are converted into Equity shares in the future at notice of the issuer. The issuer decides the ratio for conversion. This is normally decided at the time of subscription. Fully convertible Debentures (FCD): These are fully convertible into Equity shares at the issuer's notice. The ratio of conversion is decided by the issuer. Upon conversion the investors enjoy the same status as ordinary shareholders of the company. Optionally Convertible Debentures (OCD): The investor has the option to either convert these debentures into shares at price decided by the issuer/agreed upon at the time of issue. On basis of Security, debentures are classified into:

 Secured Debentures: These instruments are secured by a charge on the fixed assets of the issuer company. So if the issuer fails on payment of either, the principal or interest amount, his assets can be sold to repay the liability to the investors Unsecured Debentures: These instrument are unsecured in the sense that if the issuer defaults on payment of the interest or principal amount, the investor has to be along with other unsecured creditors of the company Also, there are some other types of Debentures, such as Senior Debentures, Secured Debentures, Exchange Debentures, Secured Convertible Debentures, Convertible Senior Debentures, Unsecured Convertible Debentures, Subordinated Convertible Debentures, Senior Secured Convertible Debentures, Junior Subordinated Debentures, Senior Subordinated Debentures, Senior Secured Debentures etc. The Advantages And Disadvantages Of Debentures for investors Whenever a company needs more money to help it function and grow, it will sometimes try to sell company bonds to people. A company bond is simply an amount of money that the company borrows from you to use on various business related expenditures. In return for using your money, the company promises to pay back the full amount of money they initially borrowed plus interest over an extended period of time. Companies also provide things that offer you financial protection in cases they are unable to pay back the amount of borrowed money and interest in the form of immediate cash. Some of this protection comes in the form of assets such as company stock or debentures, which are basically promises that the company will eventually pay you back. Company bonds can be a great thing to invest in, but they also have quite a few risks that need to be addressed before purchasing. There are a few advantages that come from investing in corporate debentures, which will be examined first in this article. These advantages are highly dependable on the success rate of the current interest rate and economic situation of society.

Greater Returns Corporate bonds and debentures are usually much more rewarding then government bonds or bank investments and provide a higher rate of financial return for their investors. If a company is selling bonds to people, it means that they definitely need the money and are willing to pay you quite a bit of additional money to use it. The fact of receiving a greater return on corporate bonds is a great advantage to these types of investment. Financially Convertible Another great advantage to debentures is that at the end of the lending period companies usually offer the assets in the form of stock, which can ultimately be very valuable. Stocks are another great form of investment and are sometimes better than receiving immediate cash in return. Although the advantages of debentures can be clearly seen, there are a number risks and disadvantages to investing in corporate bonds. Success Or Failure You are taking a great risk when investing in a corporate bond because the success of the company will determine how valuable your bond is. A company bond is only valuable when the company is successful and profitable, but if it fails, then you will lose a great amount of money. Debentures and bonds hold greater risks because the company could eventually go out of business, so this type of investment should be done very carefully. Debentures can be a very attractive form of investment, but only should be taken advantage of with companies that have a very high probability of being successful. Large and already successful businesses are smart forms of investments when considering buying corporate debentures.

Advantages & Disadvantages for the Issuing Institution Advantages for the Issuing Institution

There is an improvement in the financial structure of the company, because the extra resources (debentures) are transformed into own resources (shares). It transforms debt into capital. The financial cost is lessening, because if the investor chooses for the conversion they dont have to obey the requisites from the debentures: to pay interests and to refund the capital. On the other side, the interests from the debentures or bonds are usually lower than that on the market, this way, in case of not converting; the company will finance itself with cheap debt. The sooner the conversion is made, the greater are the discounts, so the lesser are the numbers of shares that you can obtain with each debenture.

Disadvantages for the Issuing Institution

You cant foresee an exact dividend distribution politic due those existing amounts of shares will depend on the number of debentures that will exercise their option of conversion. There are doubts when you cant calculate the interests of the debentures. Again, the number of securities to be converted is unknown or unknown of the amount of funds to be returned with the amortizations.

E.g. in the United Kingdom debentures have frequently been used as a mechanism for raising funds to build or finance sports or leisure venues. Often these debentures pay little or no interest, but entitle the holder to privileges, usually tickets for the venue. For example, the All England Lawn Tennis and Croquet Club first issued debentures in 1920 in order to purchase the current premises in Wimbledon, London, and debenture issues take place every five years. The 2001-2005 debenture issue was priced at 2,000 each, with an additional premium of 18,000, and Value Added Tax of 3,150; holders of these debentures are entitled to a free seat in the Centre Court Stand for each day of the championships for five years, and have access to exclusive lounge and catering facilities. At the Royal Albert Hall debenture holders are known as members; they own rights to individual boxes, and are entitled to view almost all performances. In 2003 Box 70 was offered on the

open market for 250,000. Other stadia financed through the issue of debentures include Millennium Stadium, Wembley Stadium, The Emirates, Twickenham Stadium, Lord's Cricket Ground, and Trent Bridge in Nottingham.Thiru