A debenture is a marketable legal contract whereby the company promises to pay its owner, a specified rate o interest for a defined period of time and to repay the principal at the specific
date of maturity. Debentures are usually secured by a chare on the immovable properties of the company.
A trustee usually represents the interest of the debenture holders and this trustee (which is typically a bank or an insurance company or a firm of attorneys) is responsible for ensuring that the borrowing company fulfills the contractual obligations embodied on the contract. If the company issues debentures with a maturity period of more than 18 months, then it has to
create a debenture redemption reserve (DRR), which should be at least half of the issue amount before the redemption commences. The company can also attach call and put options.
With the call option the company can redeem the debentures at a certain price before the maturity date and similarly the pit option allows the debenture holder to surrender the debentures
at a certain price before the maturity period.
Types of Debentures
Debentures can be classified based on the conversion and security. A few types of debentures are as follows: –
Non-convertible Debentures (NCDs)
These debentures cannot be converted into equity shares and will be redeemed at the end of the maturity period.
Fully Convertible Debentures (FCDs)
These debentures will be converted into equity shares after a specified period of time at one stroke or in installments. These debentures may or may not carry interest till date of conversion. In the case of a fully established company with as established reputation and good, stable market price, FCDs are very attractive to the investors as their bonds are getting automatically converted into shares which may be at time of conversion be quoted much higher in the market compared to what the debenture holders paid at the time of FCS issue.
Partly Convertible Dentures (PCDs)
These are debentures, a portion of which will be converted into equity share capital after a specified period, whereas the NCD portion of the PCD will be redeemed as per the terms of issue after the maturity period. The non-convertible portion of the PCD will carry interest right up to redemption, whereas the interest on the convertible portion will be only up to the date of immediately preceding the date of conversion.