Certificate.............................................................................
Acknowledgement.................................................................
Abstract .................
Introduction.......................................................................
Classification of Debentures.....
Conclusion..
Abstract
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Any informed borrower is simply less vulnerable to fraud and abuse
-Alan Greenspan
Being a qualified Company Secretary, it was an interesting task to take up topics from corporate
world. Having worked under various circumstances, one thing was clear that a project shall be
based on some real time experiences that author has faced during her professional tenure. The
concept of debenture struck in mind of author because she has seen that there is a lack of
organized debt market in India and also, during her work experience, she has faced some
challenges in legal compliance in issuing and listing of long term debt instruments: Debentures.
Introduction
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Finance is the lifeblood of every business. It is perhaps the most crucial factor in deciding fate of
any business enterprise. Finance is required in day-to-day transactions of business as well as for
carrying out capital (long term) investments of the business. Keeping this in view, it is the most
important function of a financial manager that is to arrange funds for the business from different
sources. This becomes necessary under the fact that pre determined goals of business could only
be achieved when a business does not suffer from lack of finance. It is evident in daily lives too
that a person cannot carry on his daily tasks without having financial support. Other than this,
just like daily lives, a business cannot run smoothly in absence of finance.
This therefore is the most crucial decision that a financial manager needs to take up- composition
of capital structure of an organization. Following diagram shows capital structure and its various
components:
Equity Capital
Let us get a brief introduction of each of components of capital structures:
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Equity Capital:
employed) is the interest in remaining assets, spread among individual shareholders of common
or preferred stock. At the start of a business, owners put some funding into the business to
finance assets. Businesses can be considered to be, for accounting purposes, sums of liabilities
and assets; this is the accounting equation. After liabilities have been accounted for, the positive
Preference Capital:
Preferred stock, also called preferred shares or preference shares, is typically a 'higher ranking'
stock than voting shares, and its terms are negotiated between the corporation and the investor.
Preferred stock usually carries no voting rights, but may carry superior priority over common
stock in the payment of dividends and upon liquidation. Preferred stock may carry a dividend
that is paid out prior to any dividends being paid to common stock holders. Preferred stock may
have a convertibility feature into common stock. Preferred stockholders will be paid out in assets
before common stockholders and after debt holders in bankruptcy. Terms of the preferred stock
Debt Capital:
Debt capital is the capital that a business raises by taking out a loan. It is a loan made to a
company that is normally repaid at some future date. Debt capital differs from equity or share
capital because subscribers to debt capital do not become part owners of the business, but are
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merely creditors, and the suppliers of debt capital usually receive a contractually fixed annual
percentage return on their loan, and this is known as the coupon rate.
Debt capital ranks higher than equity capital for the repayment of annual returns. This means that
legally, the interest on debt capital must be repaid in full before any dividends are paid to any
suppliers of equity.
A debenture is defined as a certificate of agreement of loans which is given under the company's
stamp and carries an undertaking that the debenture holder will get a fixed return (fixed on the
basis of interest rates) and the principal amount whenever the debenture matures.
In finance, a debenture is a long-term debt instrument used by governments and large companies
to obtain funds. It is defined as "a debt secured only by the debtors earning power, not by a lien
on any specific asset." It is similar to a bond except the security conditions are different. A
debenture is usually unsecured in the sense that there are no liens or pledges on specific assets. It
is, however, secured by all properties not otherwise pledged. In the case of bankruptcy, debenture
holders are considered general creditors. The advantage of debentures to the issuer is they leave
specific assets burden free, and thereby leave them open for subsequent financing. Debentures
are generally freely transferable by the debenture holder. Debenture holders have no voting rights
The term debenture includes debenture stocks, bonds and any other security of a company,
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Features of Debentures as a long-term financial (Debt) instrument:
Following are the basic features of debentures that differentiate them from other sources of
peculiar characteristics of debentures that make them different from commonly used finance
sources:
Investors who invest in the debentures of the company are not the owners of the
company. They are the creditors of the company or in other words, the company borrows
Funds raised by the company by way of debentures are required to be repaid during the
life time of the company at the time stipulated by the company. As such, debenture is not
In practical circumstances, debentures are generally secured i.e. the company offers some
Return paid by the company is in the form of interest. Rate of interest is predetermined,
but the company can freely decide the same. The interest on debenture is payable even if
In financial terms, debentures prove to be a cheap source of funds from the companys
point of view
So this thing needs to be kept in mind by a company that an investor is expected to invest in
debentures only when liquidity and financial position of company is very sound. An investor is
always careful before investing in any company, especially in debt instruments where there is
hardly any chance of capital appreciation. So, a company that is very much sure about it financial
well-being could very well come up with issue of debentures. Debentures are also ideal for
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companies, which do not want any kind of dilution in control of management. That means,
organizations, which do not want to issue shares, could come up with issue of debentures.
Apart from that, financial manager must make sure that company is in sound enough position to
make periodic interest payments and also, repayment of principal amount at the right time.
Classification of debentures
In India, debentures could be classified in basically two categories: on the basis of security and
Indian context:
Fully convertible Debentures (FCD): These are fully convertible into Equity
shares at the issuer's notice. The issuer decides the ratio of conversion. Upon conversion
the investors enjoy the same status as ordinary shareholders of the company.
either convert these debentures into shares at price decided by the issuer/agreed upon at
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On the basis of security:
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 instruments are unsecured in the sense that if the
issuer defaults on payment of the interest or principal amount, the investor has to be
Advantages of Debentures
Continuing the classification of debentures, next step to be undertaken during course of our
analysis is to look at fact as to how debentures have an advantage over other sources of long-
term finance. In this section of our study, we shall look as to what are the pros and cons of
debentures that make it one of the most reliable sources of long-term finance and also create a
Following are advantages of debentures that make them a reliable source of finance as compared
Let us divide our analysis into three major points i.e., division of advantages of debentures by
different prospective:
Advantages of Debentures
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General Advantages Advantages to Advantages to Financial
Investors Institutions
Let us now take a look at the description of above-mentioned topics in brief. During course of
description, efforts will be made to make sure that a reader understands relative advantage of
debentures and conclusions could be drawn out as to how under utilized this very source of
General Advantages:
These advantages are highly dependable on the success rate of the current interest rate and
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Greater Returns on Corporate Debentures: Corporate bonds and debentures
are usually much more rewarding than government debentures or bank investments and
provide a higher rate of financial return for their investors. If a company is selling
debentures to people, it means that they definitely need the money and are willing to pay
you quite a bit of additional money to use it. The fact of receiving a greater return on
the lending period companies usually offer the assets in the form of stock, which can
ultimately be very valuable. Stocks are another great form of investment and are
sometimes better than receiving immediate cash in return. Although the advantages of
debentures can be clearly seen, there are a number risks and disadvantages to investing in
corporate debentures.
Success or Failure: You are taking a great risk when investing in a corporate
debenture because the success of the company will determine how valuable your
debenture is. A company debenture is only valuable when the company is successful and
profitable, but if it fails, then you will lose a great amount of money. Debentures and
bonds hold greater risks because the company could eventually go out of business, so this
Debentures can be a very attractive form of investment, but only should be taken advantage of
with companies that have a very high probability of being successful. Large and already
successful businesses are smart forms of investments when considering buying corporate
debentures.
Advantages to investors:
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They have the possibility to acquire shares at a lower price to that of the market- by way
shares.
They have the right for subscription of shares at a lower price to that of the market.
The price of conversion is always lower to that of the market so the effects of a possible
inflation are mitigated. This inflation effects causes a rise on the stocks quotations.
There is an improvement in the financial structure of the company, because the extra
resources (debentures) are transformed into own resources (shares). It transforms debt
into capital.
The financial cost is lessening, because if the investor chooses for the conversion they
dont have to obey the requisites from the debentures: to pay interests and to refund the
capital. On the other side, the interests from the debentures or bonds are usually lower
than that on the market, this way, in case of not converting, the company will finance
The sooner the conversion is made, the greater are the discounts, so the lesser are the
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After talking about advantages of debentures, lets take a look on various demerits this source of
finance suffers from. No doubt that there are few cons from which debentures suffer, but these
demerits are small enough to overlook and advantages always override the disadvantages:
General Disadvantages:
By issuing the debentures, the company accepts the risk of two types. These are payment
of the interest at a fixed rate, irrespective of the non-availability of profits and repayment
of principal amount at the pre-decided time. If earnings of the company are not stable or
if the demand for the products of the company is highly elastic, debentures prove to be a
very risky proposition for the company. Any adverse change in the earnings or demand
Debentures are usually a secured source for raising the long-term requirement of funds
and usually the security offered to the investors is the fixed assets of the company. A
company, which requires less investment in fixed assets, such as a trading company, may
find debentures as a wrong source for raising the long-term requirement of funds, as it
The securities have a less quotation price due that temporarily they have lesser rights.
They are less liquid, due that there is a lesser amount of them.
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You cant dispose of money soon due to the former explanation. Usually the type of
interests that they offer is inferior to that of the ordinary debentures due that they offer
You cant foresee an exact dividend distribution politic due that existing amounts of
shares swill depend on the number of debentures that will exercise their option of
conversion.
There are doubts when you cant calculate the interests of the debentures. Again, the
After understanding in brief some of legal compliances related with issue of debentures in public
as well as private companies, we should conclude our analysis by taking a look at current
It is very discouraging to see that debt market in India is not as organized as in other advanced
economies. Taking example of the US, where debt market (bonds) has a size, which is more that
thrice the size of equity markets. In India, companies have been issuing debentures to public as
well as to financial institutions, but the level of issue has not been as large as equity issue. Also
markets. In India, public at large averse themselves from investing in debentures issued by large
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corporate houses. In most cases, it is financial institutions, which invest in debentures of
corporate bodies. Public at large is interested in investing in debentures which are issued by
financial institutions. In Indian markets there are about 8000 companies, which come up with
issues of securities. Out of them, only about 2000 are traded on stock exchanges on a regular
basis. Most often, there is a lack of liquidity in Indian stock markets that lead to a disinterest by
investors in debt instruments. This difference in Indian scenario with that of advanced economy
In this case illustration, we will take two companies from each nation: Reliance Industries
Limited from India and Wal-Mart Inc. from USA. We will see that both the companies have
significant effect on their respective economies and in a way they reflect financial structure and
pattern followed by investors in that nation. We will take into account respective contribution of
debt- bonds and debentures in total capital as well as total liabilities of these companies. After
this analysis, we will be in a position to draw conclusions of illustration as well as make our
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Conclusion of Analysis
It is not just about a single company, whole debt market of India needs reorganization and that
too at a rapid rate. In todays context when due to recession, equity markets have fallen
drastically in India, debentures could just help in saving day for all troubled financial markets of
India. Apart from that, government should take account of SEBIs advices when the authority has
constantly urged them to work for organization of debt market in India. This is necessary because
world activities. Role of a Company Secretary is important because in this condition hes the one
who has to maintain equilibrium between interest of investors, company and government of
India. This is perhaps real challenge that a Company Secretary will have to face in some years to
come.
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