Debentures represent long term debt instruments. The issuer of a bond promises to pay a stipulated stream of cash flows. This generally comprise periodic interest payments over the life of the instrument and principal payment at the time of redemption (s).
* An investment that resembles a company debenture carries the name of the holder(s) and is registered with the Public Debt Office (PDO). For transfer, it has to be lodged with the PDO along with a duly completed transfer deed. The PDO pays interests to the holders registered with it on the specified date of payment.
* A promissory note, issued to the original holder, which contains a promise by the President of India (or the Governor of State) to pay as per a given schedule. It can be transferred to a buyer by an endorsement by the seller. The current holder has to present the note to the Government Treasury (or a designated authorized agency) to receive interest and other payments.
* A bearer security where the interest and other payments are made to the holder of the security.
Government securities have maturities ranging from 3-20 years and carry interest rates that usually vary between 8 and 10 percent. Even though these securities carry some tax advantage, they have traditionally not appealed to individual investors because of low rates of interest and long maturities and somewhat illiquid retail markets. They are typically held by Banks, financial institutions, insurance companies, and provident funds mainly because of certain statutory compulsions.
A popular instrument, RBI savings Bonds have the following features:
1. Individuals, HUFs and NRIs can invest in these bonds.
2. The minimum amount of investment is Rs 1,000 and there is no upper limit.
3. The maturity period is 5 years from the date of issue.
4. There are two options: the cumulative option and the non-cumulative option.
5. The interest rate is 8.0 percent per annum, payable half yearly. Under the cumulative option Rs 1,000 becomes Rs 1,480 after 5 years.
6. The interest earned is taxable. The bonds are exempt from wealth tax without any limit.
7. The bonds are issued in the form if Bond Ledger Account or in the form of Promissory Notes. Bond Ledger Account can be opened in the name of the investors at the receiving offices (Designated offices of banks) and at the Public Debt Offices of RBI. Bonds in the form of promissory Notes are issued only at RBI offices.
8. The bonds are transferable. The Bond Ledger Account is transferable, wholly or in part, by execution of a prescribed transfer deed. Promissory Notes are transferable by endorsement and delivery.
9. Nomination facility is available.
10. The bonds can be offered as security to banks of availing loans.
Private Sector Debentures:
Akin to promissory notes, debentures are instruments meant for raising long term debt. The obligation of a company towards its debenture holders is similar to that of a borrower who promises to pay interest and principal at specified times. The important features of debentures area as follows:
When a debenture issue is sold to the investing public, a trustee is appointed through a deed. The trustee is usually a bank or a financial institution. Entrusted with the role of protecting the interest of debentures holders the trustee is responsible for ensuring that the borrowing firm fulfills its contracted obligations.
Typically, debentures are secured by a charge on the immovable properties both present and future of the company by way of an equitable mortgage.
All debentures issued with a maturity period of more than 18 months must be necessarily credit-rated. Further for such debentures issues a Debentures Redemption Reserve (DRR) has to be created. The company should create a DRR equivalent to at least 50 percent of the amount of issue before redemption commences.
Previously the coupon rate (or interest rate) on debentures was subject to a ceiling fixed by the Ministry of Finance. No such ceiling applies now. A company is free to choose the coupon ate. Further, the rate may be fixed or floating. In the latter case it is periodically determined in relation to some benchmark rate.
Earlier the average redemption period for non-convertible debentures was about seven years. Now there is no such restriction. A company has the freedom to choose the redemption (maturity) period.
Debentures sometimes carry a call features which provides the issuing company with an option to redeem the debentures at a certain price before the maturity date. Sometimes, the debentures may have a ‘put’ feature which gives the holder the right to seek redemption at specified times at predetermined prices.
Debentures may have a convertible clause gives the debenture holder the option to convert the debentures into equity shares on certain terms and conditions that are pre-specified.