Debentures are long-term debt instruments issued by corporations and governments to raise capital. Debentures represent a loan taken by the issuer for a specified period with fixed interest payments.
When you purchase a debenture, you are essentially lending money to the issuer. In return, the issuer promises to make regular interest payments (known as coupon payments) to you for a specified period. At the end of the debenture’s term, the principal amount is repaid to you.
Debentures are generally issued in the form of certificates or bonds and are backed by the issuer’s creditworthiness.
Debenture Credit Ratings
You will receive the interest rate on debentures based on the company’s credit rating, which is measured by credit-rating agencies. These agencies measure the creditworthiness of corporate and government issues.
These ratings help you make informed decisions by providing an independent opinion on the company’s ability to meet their financial obligations. The assigned rating indicates the level of risk associated with the debenture, with higher ratings reflecting lower perceived risk.
When assigning debenture ratings, credit rating agencies analyze various factors, including financial stability, debt levels, cash flow position, industry dynamics, and overall economic conditions. They conduct a thorough evaluation of the company’s financial statements, market position, management quality, and governance practices.
Credit rating agencies like Standard and Poor’s, use letter grades to indicate creditworthiness. The Standard & Poor’s system uses a scale that ranges from AAA for excellent rating to the lowest rating of C and D.
The higher the rating, the lower the perceived risk associated with the debentures. Ratings in the AAA to BBB range are considered investment-grade, indicating a lower risk of default.
Ratings below the investment-grade range such as BB and below, are classified as speculative or non-investment grade, implying a higher risk profile.
Additionally, credit rating agencies such as Moody’s and FitchRatings provide their own credit rating scales for long-term debentures. These scales serve as benchmarks for assessing the creditworthiness of issuers and include:
Credit Ratings Scale: Highest to Lowest
|Standard & Poors||Moody’s||FitchRatings|
Features Of Debentures
- Written Promise: Debentures are written documents from the issuer to the investor. The terms and conditions of the debenture, including the interest rate, repayment schedule, and other relevant details, are clearly outlined in a formal written document. This provides legal certainty and ensures that both parties understand their rights and obligations.
- Fixed Interest Payments: Debentures offer a fixed rate of interest, known as the coupon rate, which is predetermined at the time of issuance. You can receive regular interest payments at specified intervals throughout the debenture’s term.
- Maturity Date: Debentures have a defined maturity date, indicating the date on which the issuer is obligated to repay the principal amount to the debenture holders. This provides clarity on the duration of the investment.
- Priority claim: In case of liquidation or bankruptcy, you have a prior claim on the issuer’s assets compared to equity shareholders. Debenture holders are typically repaid their principal amount before equity shareholders receive any distributions. This priority claim enhances the security and potential recovery for debenture holders in adverse situations.
- Credit Rating: Debentures are often assigned credit ratings by recognized rating agencies, reflecting the issuer’s creditworthiness. These ratings provide you with insights into the level of risk associated with the investment.
Types Of Debentures
Debentures can be classified into various types based on their characteristics and features. Let’s explore some common types:
#1. Based on Convertibility
A. Convertible Debentures: Convertible debentures provide you with the option to convert your debentures into equity shares at a predetermined conversion ratio after a specific period. This feature provides the potential for capital appreciation and allows you to participate in the company’s growth.
Convertible debentures are of two types.
- Fully Convertible Debentures: Fully convertible debentures can be fully converted into equity shares at the predetermined conversion ratio, allowing you to participate in the company’s growth.
- Partly Convertible Debentures: Partly convertible debentures enable you to convert only a portion of your debentures into equity shares, while the remaining portion remains as non-convertible with fixed interest payments.
B. Non-Convertible Debentures: Non-convertible debentures cannot be converted into equity shares. These debentures provide fixed interest rates and repay the amount to you at maturity.
#2. Based on Security
A. Mortgage/Secured Debentures: Mortgage or secured debentures are issued against collateral security. This provides an added layer of security to you. In case of default, you can claim the underlying asset to recover your investment.
These types of debentures offer a lower risk to the debenture holder and, therefore, generally provide a lower rate of interest compared to unsecured debentures.
B. Unsecured Debentures: Unsecured debentures also known as unsecured bonds or debenture bonds, are not backed by any collateral. The debenture holder relies solely on the creditworthiness and reputation of the company.
In case of default, unsecured debenture holders are considered general creditors and have a lower priority in recovering their investment compared to secured debenture holders.
#3. Based on Redemption
A. Redeemable Debentures: Redeemable debentures have a specific maturity date, upon which the issuer is obligated to repay the principal amount to the investors. Investors receive regular interest payments until maturity.
These debentures provide a clear timeline for the return of the principal investment and are commonly issued by both corporations and governments.
B. Irredeemable Debentures: Irredeemable debentures, also known as perpetual debentures, do not have a maturity date. The redemption happens only when the issuing company is liquidating or a specific contractual provision.
The debenture holder receives regular interest payments indefinitely, without the expectation of the principal repayment.
#4. Based on Registration
A. Registered Debentures: Registered debentures are those in which the details of all debenture holders, such as names, addresses, debenture holdings, are recorded in the company’s register.
However, transferring registered debentures is a more complex process, as it involves complying with the provisions outlined in the Companies Act, 2013.
B. Bearer Debentures: Bearer debentures, also known as unregistered debentures, the details of all debenture holders are not registered with the company. These debentures are freely transferable which means you can easily buy and sell them.
How To Invest In Debentures
You can also invest in debentures through Zerodha, Golden Pi, Upstox, and Groww. However, before investing in debentures, you need to open a demat account.
Now I am taking an example of Zerodha to invest in debentures. Follow these steps:
You can diversify your portfolio by investing in debentures through Zerodha in two ways:
- Trading in the secondary market via Zerodha Kite app.
- Directly invest in debentures via Zerodha Coin app or web.
You can invest in the non-convertible debentures (NCDs) through Zerodha. The NCDs instruments are listed in the N series of N1 to N9 and NA to NZ..
#1. Invest in Debentures via Zerodha Kite App
Step #1. Log in to the Zerodha kite app using your credentials. You can open the demat account with Zerodha if you do not have a demat and a trading account.
Step #2. You can search the company’s name in the universal search bar and the debentures listed under it will be displayed.
Step #3. Select the debenture which you want to invest in and click on the “Buy” button.
Step #4. Enter the quantity with investment horizon, set the price, and choose the market types such as market order, limit order and stop loss.
Step #5. Then click on the “Buy” button.
Step #6. Your order will be completed successfully. You can track your order under the “holding” section.
#2. Invest Directly in Debentures via Zerodha Coin
Step #1. Log in to the Zerodha Coin web or app using your credentials.
Step #2. Go to the “Dashboard” and select the “corporate bond” from the dropdown menu.
Step #3. Select the debenture/bond which you want to invest in and click on the “Invest” button.
Step #4. Enter the units to buy and then click on “Initiate order.”
Step #5. Select on the consent checkbox and then click on “Proceed to Payment” to confirm the purchase.
Step #6. On completion of payment, your order will be completed successfully. In case your payment has failed, you can re-initiate the payment by clicking on ‘Complete Payment’ in Pending orders.
Make sure you have a sufficient balance in your linked bank account. Because the payment will be deducted from your bank account instead of a trading account.
You may also like to read the step-by step guide on how to invest in government bonds in India.
Yes, debentures can be traded in the secondary market, allowing you to buy or sell them before their maturity. This provides liquidity and potential opportunities for capital appreciation or early exit from the investment.
You can assess the creditworthiness of the debenture issuer by reviewing their financial statements, examining their credit ratings provided by recognized rating agencies, and analyzing their past performance, repayment track record, and industry standing.
The minimum investment required for debentures varies depending on the issuer and the specific debenture offering. It is advisable to check the terms and conditions of the debenture issuance to determine the minimum investment amount.
Yes, you can invest in debentures, providing them with an opportunity to diversify your investment portfolio and earn fixed income through regular interest payments.
The interest rate is predetermined by the company. You can calculate the interest rate on debentures’ face value.
The interest income earned from debentures is considered as income from other sources and taxable as per your income tax slab rate.
Bonds and debentures are both types of debt instruments, but the main difference lies in their issuer. Bonds are generally issued by governments or large corporations, while debentures are issued by corporations.
Additionally, bonds often have a higher level of security and priority in repayment compared to debentures.
Shares represent ownership in a company with voting rights and potential for dividends, while debentures are debt instruments that represent a loan to the company and offer fixed interest payments and repayment of principal.