Debentures: An Alternative Investment in India’s Financial Market

by | Apr 4, 2024 | 0 comments

Among the numerous ways of investing in India, debentures are an investment avenue that has attracted a lot of attention from investors who want diversification and stability. These instruments have become preferred as they offer higher return and lower risk compared to stocks over medium or long-term holding periods. This report will discuss debenture’s concept, types, advantages, risks and its place in the financial market of India.

What is Debenture?

Debenture is a type of long term unsecured debt instrument. Just like loans, they come with a predetermined interest rate payable over time by the company which offers it to the public. The principal amount is paid back at maturity while periodic interest payments are made to holders of debentures.

Types of Debentures

Understanding various types of debentures helps investors make right decisions in India’s financial markets. Debentures are essentially borrowed funds taken by organizations; these borrowings could be classified into various categories based on their features; benefits and drawbacks. Here we will give consideration to principal classes concerning debentures open to Indian shareholders:

1. Secured vs Unsecured Debentures

a. Secured Debentures:

Backed by issuer’s assets these debts can be referred as secured. In case of default on these debts, there are some funds that can be claimed by secured debenture holders as repayment recourse due to having this kind of security measure mitigates risk for investing into such ventures as opposed to unsecured ones again used by institutions when raising significant amounts at cheaper borrowing costs for investors due reduced exposure.

b. Unsecured Debentures:

Unlike their secured counterparts, unsecured debentures do not have any assets pledged against them unlike the former which have some assets collateralized against them Companies issue these based purely on good name or creditworthiness without having anything else .Given the increased risk resulting from lack backing , hence usually earn some more interests . The decision to invest in unsecured debentures depends mostly on the issuers’ creditworthiness and financial records at that time.

2. Convertible vs Non-Convertible Debentures

a. Convertible Debentures:

These are debentures that come with a provision for conversion into a specified number of equity shares of an issuing company after a given duration. This can either be done by the holder or as per the conditions set down by the issuing firm. These investments provide a chance to enjoy income levels and growth potential which are associated with both debts and equities.

b. Non-Convertible Debentures (NCDs):

NCDs are fixed income securities that cannot be converted into equity shares of the company which issued them at any stage if its life cycle ends .During their term, they earn a fixed coupon rate thus paid back on maturity date. Fixed interest income is what investors get from such instruments while saving themselves against shocks originating from stock exchange price fluctuations. It is common for investors seeking stability, therefore, go for NCDs as safer alternative against possible losses compared to convertible debenture.

3. Redeemable vs Irredeemable (Perpetual) Debentures

a. Redeemable Debentures:

The period upon which principal is returned to debenture holders leads to creation of redeemable debentures where some maturity date runs out. Majority of these debentures in circulation tend to have end periods providing clarity over payback periods as well return period of investment capital for traders here in India.

b. Perpetual Debentures (Irredeemable):

Such debentures are rarely issued and do not have a fixed maturity date. The principal amount is never paid back during the lifetime of the investors who continue receiving interests at infinity. Sometimes, the issuer will refund only the principal after calling in the debenture, which may be never done. They are not common as they are perpetual and hence cannot appeal to all.

4. Registered vs. Bearer Debentures

a. Registered Debentures:

These are included in the register which is kept by an issuing company for debenture holders. Interest and principal payments go directly to those who are recorded on it. Name change on the register acts as a safeguard but also reduces liquidity when ownership changes hands.

b. Bearer Debentures:

In contrast to registered debentures, bearer debentures do not appear on a company’s register. Here, payment goes to any person holding or bearing such note for money purposes or otherwise. For instance, they can be assigned merely by delivery hence liquid but risky.

Benefits of Investing in Debentures

Debenture investments offer many benefits that make them useful to different categories of Indian financial market investors. These include returns oriented investment, safe harbor provisions with respect to returns and diversification opportunities for portfolio’s investment mix. Below is a detailed consideration of key merits accruing from investing in debentures:

1. Regular and Predictable Income

Interest earned from debenture bonds comes in form of coupon payments made regularly over time till maturity called “coupon” because it does not vary regardless of economic conditions until maturity period is reached (Moyer et al., 2019). Investors that need periodic income like retired people invest in these types of instruments so that they balance their portfolios with reliable debt obligations.

2.Higher Interest Rates than Savings Accounts or Fixed Deposits

Generally speaking, traditional bank deposits such as savings accounts and fixed deposits pay lower interest rates than debentures. This is because they are riskier, especially those that do not have any security. They also cost more than savings accounts in terms of opportunity costs as people are forced to forego interest on these cash holdings (Moyer et al., 2019). Therefore, investing in debentures might offer higher returns compared with keeping money idle or heavily discounted.

3.Capital Appreciation

In addition to receiving fixed income through interest payments, convertible debentures may offer capital appreciation. The investor can convert the debenture into equity of the issuing company at a predetermined price. These shares, if the company does well, can appreciate over time giving rise to capital gains apart from the interests on the debenture.

4.Safety and Security

Secured Debentures: Secured debentures are backed by specific assets or security making them less risky compared with unsecured debentures or equity market instruments (Moyer et al., 2019). In case of liquidation of a firm secured bondholders rank higher than shareholders meaning that their position is much safer. Risk-averse investors prioritize capital preservation and this level of security facilitates it.

5.Tax Benefits

Certain classes of debenture offer tax advantages. For example, Government recognized infra bonds attract tax benefits as per certain sections of Income Tax Act (Khan et al., 2020). This could increase overall return on investment for taxpayers making such types very much popular among them as tax saving options.

6. Diversification

Thus, it is important to invest in debentures as a way of diversification and as a means of managing risk. Diversifying by combining debentures with stocks, mutual funds, and other securities enables investors to spread the risk across various asset classes. Thus the investment dynamics are shifted which leads to more consistent gains and thus prevents cases of fluctuations within the single classes.

7. Liquidity

To facilitate trading before maturity; major stock exchange listing for non-convertible debentures (NCD) enhances liquidity among other benefits. This can be beneficial especially when there are emergencies or when one wants to change their investments, unlike other fixed income investments such as bank fixed deposits.

Risks Associated with Debentures

  • Credit Risk: Default by the issuing company can lead to loss of interest or principal.
  • Interest Rate Risk: Market interest rate changes may affect the market value of debentures.
  • Liquidity Risk: Some debentures may have low liquidity, making them difficult to sell prior to maturity at advantageous prices.

Read Also: Trading Volume and Its Impact on the Indian Stock Market

Debentures in India’s Financial Market

In that sense; corporate debenture has been preferred choice for conservative investors who prefers lower-risk instruments with fixed returns rather than going for other options available in market. The market for corporate debenture has been growing rapidly owing to companies needing alternative funding sources besides traditional bank loans.

The regulatory environment led by Securities Exchange Board of India ensures transparency and protection for investors thereby fostering confidence in the bond market. In addition, several platforms where bonds can be traded have been introduced enhancing liquidity hence making it possible for people to buy and sell these bonds.

How to Invest in Debentures?

You can participate in primary markets during issuance or use secondary markets if you want to invest money into Indian debenture markets. Many online trading platforms and financial institutions provide opportunities for individual investors wishing to invest into bonds hence they are accessible even through this route.

Conclusion:

It is in this regard that debenture investments are a viable option for any investor seeking to diversify his/her investment from shares and traditional fixed deposits. With different types, relatively low risk and stable income potential, the available choices in debentures cater for different preferences of investors. However, like all investments, it is important to evaluate the risks especially credit worthiness of the issuer and perform due diligence prior to making any investments. As India’s financial market develops further, debentures will likely become more prominent instruments supporting both businesses as well as individuals with a flexible funding or investing outlet which is also fast and efficient.

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