Derived from the Latin word ‘debere’ which means to borrow, a debenture is an acknowledgement of a debt that any organisation has taken from entities within an economy. Companies and firms use this financial instrument to raise long-term debt capital. There are numerous debentures types based on the point of view from various particulars such as security, tenure, convertibility, etc.
A debenture issued by an organisation is an official authentication that an organisation has borrowed a certain sum of money from the public. The borrowed sum comes with a promise that the organisation will repay the amount on or before a specified date in the future. So, debenture holders can also be referred to as creditors of an organisation.
A debenture is a note of promise of a corporate bond that is usually backed by the reputation and integrity of borrowers and also specific assets of borrowers. The borrower is usually a company or a firm, and the lender is the public.
In simpler terms, debentures are nothing but another variant of debt instruments that rely primarily on the general creditworthiness of an issuer to raise borrowed capital. Both public and private sector companies issue such a type of corporate bond to secure capital. Just like all other types of bonds, debentures are also documented in an indenture.
A perfect debenture example would be any kind of government-issued treasury bond. Such bonds, known as treasury bills are regarded as risk-free as the government, in the worst-case scenario, can print more money or raise tax rates of the country to pay off its debts.
There are several kinds of debentures, and they can be categorised according to the following particulars –
Redemption or Tenure
Under this category, debentures can be subdivided into 2 types:
Such debentures hold a particular date of redemption which is mentioned on the certificate. An organisation is legally entitled to repay the principal amount to their debenture holders before the redemption date.
This type of debentures does not carry any specific time of redemption on their repayment terms. For irredeemable debentures, redemption is made possible by the liquidation of the issuing body or as per any agreements between the concerned parties.
Based on convertibility, debentures can be further classified as:
In the case of such debentures, holders can exercise their right to convert all of their holdings into equity shares. Such debentures can be thereby subdivided further into fully and partially convertible debentures.
For non-convertible debentures, holders do not have the option of converting their holdings into equity shares, and it will always remain as debt for the whole of the tenure.
From the point of security of the borrowed sum, debentures can be grouped into two parts:
Such debentures are secured by some asset or set of assets which the holders can liquidate if needed. These debentures can be further classified as first mortgaged and second mortgaged debentures.
When the debentures are issued solely by leveraging the creditworthiness and goodwill of a company, it is known as unsecured debentures or naked debentures.
Transferability or Registration
As per transferability and registration, debentures can be subdivided into:
In the case of registered debentures, the name and address of the debenture holder and information pertinent to holding are registered with the issuing organisation.
Unregistered or Bearer Debentures
Such debentures can be transferred easily to a new holder as details of the previous holder are not registered with the issuing company.
Types of Interest Rate
Debentures can be differentiated according to their type of interest rates, which are:
Floating - Rate Debentures
This type of debenture accrues interest at a floating rate for the whole of its tenure.
Fixed - Rate Debentures
The interest rate of such debentures is immune to alterations in market rates and remains fixed for the entirety of the holding tenure.
Depending on the presence of coupon rates, Debentures are classified as follows:
Zero - Coupon Rate Debentures
Such debentures do not have a coupon rate which means that holders are not liable to receive any interest payment.
Specific - Coupon Rate Debentures
These are normal debentures which have a specific interest rate.
Secured Premium Facility
This kind of debentures offer issuers with the facility of redeeming at a premium over the face value of the debentures.
Mode of Redemption
Debentures are also categorised as per their mode of redemption, which is as follows:
Here, issuing companies and firms possess the rights to redeem the debentures before the tenure is over at a premium to the holder or investor.
In this case, debenture holders can request the organisation for settling the loan through principal payment.
These debentures are given higher priority of settlement compared to other debts in case a company is forced to opt for liquidation.
Such types of debentures are common in the field of venture capital financing. Interest is carried out in three phases where no interest is charged during the initial phase. During the middle phase, a lower rate of interest is charged while in the final phase, the rate of interest applicable is comparatively higher.
If you want to dive into a detailed explanation of the different types of debentures and their examples, make sure to visit the official website of Vedantu.
1. On What Basis can we Classify Different Types of Debentures?
The different types of Debentures can be showcased with the following parameters - redemption/tenure, convertibility, security, transferability/registration, type of interest rate, coupon rate and mode of redemption.
2. Define Debentures and Mention its Various Types.
A debenture can be defined as an official document that states that a debt is accepted under general authentication of an organisation. Such a document shows the agreement of repayment of the borrowed sum after a specific period.
So, a written financial instrument used by companies and organisations to issue a loan is called Debentures, and its types are – Convertible and Non-Convertible, Secured and Unsecured, Registered and Unregistered Or Bearer, Fixed-Rate and Floating Rate, Zero-Coupon Rate, Specific Coupon Rate, Secured Premium Facility, Callable, Puttable, Subordinated and Participating.