ABriefNoteonDebentures

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WhatisaDebenture?
ADebentureisadebtsecurityissuedbyacompany(calledtheIssuer),whichofferstopayinterestin
lieuofthemoneyborrowedforacertainperiod.
ThesearelongtermdebtinstrumentsIssuedbyPrivateSectorCompanies.
TheseareissuedindenominationsaslowasRs1000andhavematuritiesrangingbetweenone
andtenyears.
DebenturesenableinvestorstoreaptheDualBenefitsofAdequateSecurityandGoodReturns.
UnlikeotherFixedIncomeInstrumentssuchasFixedDeposits,BankDepositstheycanbe
transferredfromonepartytoanotherbyusingtransferfrom.
Debentureswereissuedinphysicalform.Nowcorporate/PSUshavestartedissuingdebentures
inDematform.
Debenturescanbelistedonastockexchange,givingyouanopportunitytosellthemandexit
earlierthenthetenureofthedebenture.
InSimpleWords,Adebentureisadebtinstrument,justlikeafixeddeposit(FD),usuallyissuedbya
company.Youinvestasum,andthecompanypaysyouafixedrateofinterestforthepredefined
period.Aftertheperiodgetsover,yougetbackyourprincipalamount.
So,whatisthedifferencebetweenadebentureandacompanyfixeddeposit(FD)?Theyareverysimilar
butthekeydifferenceisliquidity.
Whatarethedifferenttypesofdebentures?
Debenturesaredividedintodifferentcategoriesonthebasisof:(1)convertibilityoftheinstrument(2)
Security
Debenturescanbeclassifiedonthebasisofconvertibilityinto:
NonConvertibleDebentures(NCD):Theseinstrumentsretainthedebtcharacterandcannotbe
convertedintoequityshares
PartlyConvertibleDebentures(PCD):ApartoftheseinstrumentsareconvertedintoEquity
sharesinthefutureatnoticeoftheissuer.Theissuerdecidestheratioforconversion.Thisis
normallydecidedatthetimeofsubscription.
FullyconvertibleDebentures(FCD):ThesearefullyconvertibleintoEquitysharesattheissuer's
notice.Theratioofconversionisdecidedbytheissuer.Uponconversiontheinvestorsenjoythe
samestatusasordinaryshareholdersofthecompany.
OptionallyConvertibleDebentures(OCD):Theinvestorhastheoptiontoeitherconvertthese
debenturesintosharesatpricedecidedbytheissuer/agreeduponatthetimeofissue.

ABriefNoteonDebentures

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OnbasisofSecurity,debenturesareclassifiedinto:
SecuredDebentures:Theseinstrumentsaresecuredbyachargeonthefixedassetsofthe
issuercompany.Soiftheissuerfailsonpaymentofeithertheprincipalorinterestamount,his
assetscanbesoldtorepaytheliabilitytotheinvestors
UnsecuredDebentures:Theseinstrumentareunsecuredinthesensethatiftheissuerdefaults
onpaymentoftheinterestorprincipalamount,theinvestorhastobealongwithother
unsecuredcreditorsofthecompany.
Whatisexactlymeantbythetermsecuredredeemabledebenture?
Securedreferstothesecuritygivenbytheissuerfortheloantransactionrepresentedbythe
debenture.
Thisisusuallyintheformofafirstmortgageorchargeonthefixedassetsofthecompanyona
paripassubasiswithotherfirstchargeholderslikefinancialinstitutionsetc.
Sometimes,thechargecanalsobeasecondchargeinsteadofafirstcharge.Mostofthetimes
thechargeiscreatedonbehalfoftheentirepoolofdebentureholdersbyatrusteespecifically
appointedforthepurpose.
Redeemablereferstotheprocesswherebythedebentureisextinguishedonpaymentofallthe
obligationsduetotheholderaftertherepaymentofthelastinstallmentoftheprincipalamount
ofthedebenture.
Whatisadifferencebetweenabondandadebenture?
LongtermdebtsecuritiesissuedbytheGovernmentofIndiaoranyoftheStateGovernmentsor
undertakingsownedbythemorbydevelopmentfinancialinstitutionsarecalledasBONDS.
InstrumentsissuedbyotherentitiesarecalledDEBENTURES.
Thedifferencebetweenthetwoisactuallyafunctionofwheretheyareregisteredandpay
stampdutyandhowtheytrade.
WhatistheCouponrateoftheSecurity?
TheCouponrateissimplytheinterestratethateverydebenture/Bondcarriesonitsfacevalueandis
fixedatthetimeofissuance.
Forexample,a12%p.acouponrateonabond/debentureofRs100impliesthattheinvestor
willreceiveRs12p.a.Thecouponcanbepayablemonthly,quarterly,halfyearly,orannuallyor
cumulativeonredemption

ABriefNoteonDebentures

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WhatismeantbyaMaturitydateforSecurity?
Securitiesareissuedforafixedperiodoftimeattheendofwhichtheprincipalamountborrowedis
repaidtotheinvestors.Thedateonwhichthetermendsandproceedsarepaidoutisknownasthe
Maturitydate.Itisspecifiedonthefaceoftheinstrument.
InrespectofDematDebtinstrumentduedateisknownfromISINNumberofthesecurity.
WhatisRedemptionofBond/Debenture?
Onreachingthedateofmaturity,theissuerrepaysthemoneyborrowedfromtheinvestors.Thisis
knownasRedemptionorRepaymentofthebond/debenture.
Iftheredemptionproceedsaremorethanthefacevalueofthebond/debentures,thedebenturesare
saidtoberedeemedatapremium.Ifonegetslessthanthefacevalue,thentheyareredeemedata
discountandifonegetsthesameastheirfacevalue,thentheyareredeemedatpar.
WhatismeantbyCurrentyield?

Thisistheyieldorreturnderivedbytheinvestoronpurchaseoftheinstrument(yieldrelatedto
purchaseprice)
Itiscalculatedbydividingthecouponratebythepurchasepriceofthedebenture.Fore.g:Ifan
investorbuysa10%Rs100debentureofABCcompanyatRs90,hiscurrentYieldontheinstrument
wouldbecomputedas:
CurrentYield=(10%*100)/90X100,Thatis11.11%p.a.
WhatisYieldtomaturity(YTM)?

TheyieldorthereturnontheinstrumentisheldtillitsmaturityisknownastheYieldtomaturity(YTM).
ItbasicallymeasuresthetotalincomeearnedbytheinvestorovertheentirelifeoftheSecurity.

Thistotalincomeconsistsofthefollowing:
Couponincome:Thefixedrateofreturnthataccruesfromtheinstrument
Interestoninterestatthecouponrate:Compoundinterestearnedonthecouponincome
Capitalgains/losses:Theprofitorlossarisingonaccountofthedifferencebetweenthepricepaidfor
thesecurityandtheproceedsreceivedonredemption/maturity.

ABriefNoteonDebentures

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WhatisPutandCallOptionsinDebentures?
Debenturescanhaveputand/orcalloptions.
Aputoptionmeansthatyouhaveanoptiontosurrenderthedebentureifyouwantto,and
getbackyourprincipal.
Acalloptionmeansthatthecompanyhasanoptiontoaskyoutosurrenderthedebenture,
andpaybacktheprincipaltoyou.
Aputoptiongivesalotofflexibilitytoyouifinterestratesgoup,andyoucangetbetter
ratesfromthemarket,youcanexercisetheputoptionandgetbackyourmoney.Youcaninvest
itelsewhere,andgetbetterinterest.
Acalloptiongivesflexibilitytothecompanyifinterestratesgodown,andthecompanycan
getfundsatlowerratesfromthemarket,itcanexercisethecalloptionandgiveyourmoney
backtoyou.Itcanthenraisemoneyfromthemarketatlowerrates.
IncomeTaxTreatment?
Forincometaxpurpose,thedebenturesaretreatedlikedebtinstruments.
Sincedebentureisacapitalasset.
Ifyousellthedebentureonthestockexchangebeforeholdingitforayear,itwouldbeaShort
TermCapitalGainitwouldbeincludedinyourincomeandwouldbetaxasperprevailingIT
slabs.
Ifyousellitonanexchangeafterholdingitforayearormore,thegainwouldbelongterm
capitalgain.ThisLTCG(LongTermCapitalGain)shouldbecalculatedwithoutindexation,and
wouldbetaxedat10%ofthegain.