A Brief Note on Debentures

What is a Debenture?
A Debenture is a debt security issued by a company (called the Issuer), which offers to pay interest in
lieu of the money borrowed for a certain period.
• These are long‐term debt instruments Issued by Private Sector Companies.
• These are issued in denominations as low as Rs 1000 and have maturities ranging between one and ten years.
• Debentures enable investors to reap the Dual Benefits of Adequate Security and Good Returns.
• Unlike other Fixed Income Instruments such as Fixed Deposits, Bank Deposits they can be transferred from one party to another by using transfer from.
• Debentures were issued in physical form. Now corporate/PSUs have started issuing debentures in Demat form.
• Debentures can be listed on a stock exchange, giving you an opportunity to sell them and exit earlier then the tenure of the debenture.

In Simple Words, A debenture is a debt instrument, just like a fixed deposit (FD), usually issued by a company. You invest a sum, and the company pays you a fixed rate of interest for the pre‐defined period. After the period gets over, you get back your principal amount. So, what is the difference between a debenture and a company fixed deposit (FD)? They are very similar – but the key difference is liquidity.

What are the different types of debentures?
Debentures are divided into different categories on the basis of: (1) convertibility of the instrument (2) Security
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.

What is exactly meant by the term secured redeemable debenture?
• Secured refers to the security given by the issuer for the loan transaction represented by the debenture.
• This is usually in the form of a first mortgage or charge on the fixed assets of the company on a pari passu basis with other first charge holders like financial institutions etc.
• Sometimes, the charge can also be a second charge instead of a first charge. Most of the times the charge is created on behalf of the entire pool of debenture holders by a trustee specifically appointed for the purpose.
• Redeemable refers to the process whereby the debenture is extinguished on payment of all the obligations due to the holder after the repayment of the last installment of the principal amount of the debenture.

What is a difference between a bond and a debenture?
Long‐term debt securities issued by the Government of India or any of the State Government’s or undertakings owned by them or by development financial institutions are called as BONDS. Instruments issued by other entities are called DEBENTURES. The difference between the two is actually a function of where they are registered and pay stamp duty and how they trade.

What is the Coupon rate of the Security?
The Coupon rate is simply the interest rate that every debenture/Bond carries on its face value and is fixed at the time of issuance.
For example, a 12% p.a coupon rate on a bond/debenture of Rs 100 implies that the investor will receive Rs 12 p.a. The coupon can be payable monthly, quarterly, half‐yearly, or annually or cumulative on redemption

What is meant by a Maturity date for Security?
Securities are issued for a fixed period of time at the end of which the principal amount borrowed is repaid to the investors. The date on which the term ends and proceeds are paid out is known as the Maturity date. It is specified on the face of the instrument. In respect of Demat Debt instrument due date is known from ISIN Number of the security.

What is Redemption of Bond/Debenture?
On reaching the date of maturity, the issuer repays the money borrowed from the investors. This is known as Redemption or Repayment of the bond/debenture. If the redemption proceeds are more than the face value of the bond/debentures, the debentures are said to be redeemed at a premium. If one gets less than the face value, then they are redeemed at a discount and if one gets the same as their face value, then they are redeemed at par.

What is meant by Current yield?
This is the yield or return derived by the investor on purchase of the instrument (yield related to purchase price)
It is calculated by dividing the coupon rate by the purchase price of the debenture. For e. g: If an investor buys a 10% Rs 100 debenture of ABC company at Rs 90, his current Yield on the instrument would be computed as: Current Yield = (10%*100)/90 X 100 , That is 11.11% p.a.

What is Yield to maturity (YTM)?
The yield or the return on the instrument is held till its maturity is known as the Yield‐to‐maturity (YTM). It basically measures the total income earned by the investor over the entire life of the Security. This total income consists of the following:
Coupon income: The fixed rate of return that accrues from the instrument Interest‐on‐interest at the coupon rate: Compound interest earned on the coupon income Capital gains/losses: The profit or loss arising on account of the difference between the price paid for the security and the proceeds received on redemption/maturity.

What is Put and Call Options in Debentures?
Debentures can have put and / or call options.
• A “put” option means that you have an option to surrender the debenture if you want to, and get back your principal.
• A “call” option means that the company has an option to ask you to surrender the debenture, and pay back the principal to you.
• A put option gives a lot of flexibility to you – if interest rates go up, and you can get better rates from the market, you can exercise the put option and get back your money. You can invest it elsewhere, and get better interest.
• A call option gives flexibility to the company – if interest rates go down, and the company can get funds at lower rates from the market, it can exercise the call option and give your money back to you. It can then raise money from the market at lower rates.

Income Tax Treatment?
For income tax purpose, the debentures are treated like debt instruments. Since debenture is a capital asset.
• If you sell the debenture on the stock exchange before holding it for a year, it would be a Short Term Capital Gain – it would be included in your income and would be tax as per prevailing IT slabs.
• If you sell it on an exchange after holding it for a year or more, the gain would be long term capital gain. This LTCG (Long Term Capital Gain) should be calculated without indexation, and would be taxed at 10% of the gain.