Debenture Types: Top 13 Types of Debenture

This article throws light upon the top thirteen types of debenture. The types are:  1. Simple, Naked or Unsecured Debentures 2. Secured or Mortgaged Debentures 3. Bearer Debentures 4. Registered Debentures 5. Redeemable Debentures 6. Irredeemable Debentures 7. Convertible Debentures 8. Zero Interest Bonds / Debentures 9. Zero Coupon Bonds 10. First Debentures and Second Debentures and Others.

Type # 1. Simple, Naked or Unsecured Debentures:

These debentures are not given any security on assets. They have no priority as compared to other creditors. They are treated along with unsecured creditors at the time of winding up of the company. So, they are just unsecured creditors.

Type # 2. Secured or Mortgaged Debentures:

These debentures are given security on assets of the company. In case of default in the payment of interest or principal amount, debenture-holders can sell the assets in order to satisfy their claims. The debentures may be given a floating charge over all assets of company. In this case debentures are paid in priority to unsecured creditors. The sale proceeds of assets are first applied to pay debentures with a floating charge.

Type # 3. Bearer Debentures:

These debentures are easily transferable. They are just like negotiable instruments. The debentures are handed over to the purchaser without any registration deed. Anybody purchasing them with a consideration and in good faith becomes the lawful owner of the debentures. The coupons for interest are attached to the debentures. The bearer can get interest from the company’ bank when it becomes due.

Type # 4. Registered Debentures:

As compared to bearer debentures which are transferred by mere delivery, registered debentures require a procedure to be followed for their transfer. Both the transfer and the transferee are expected to sign a transfer voucher. The form is sent to the company along with the registration fees.

The name of the purchaser is entered in the register. The coupons for interest are sent only to the persons in whose names the debentures are registered. Every transfer of debenture requires the same transfer procedure to be repeated.

Type # 5. Redeemable Debentures:

These debentures are to be redeemed on the expiry of a certain period. The interest on the debentures is paid periodically but the principal amount is returned after a fixed period. The time for redeeming the debentures is fixed at the time of their issue.

Type # 6. Irredeemable Debentures:

Such debentures are not redeemable during the life time of the company. They are payable either on the winding up of the company or at the time of any default on the part of the company. The company can retain the right to redeem these debentures after giving due notice to the debenture-holders.

Type # 7. Convertible Debentures:

Sometimes convertible debentures are issued by a company and the debenture-holders are given an option to exchange the debentures into equity shares after the lapse of a specified period.

However, debentures issued at discount can be converted either into the equivalent number of shares (representing the nominal amount of debentures), credited as paid-up in proportion to the cash originally paid on the nominal value of debentures or into the proportionately reduced number of fully paid- up shares.

Convertible debentures give an investor the privilege of being a secured creditor of the company and to change his status to that of a shareholder if the returns are lucrative and the company is financially strong.

Convertible debentures may be either’ Fully Convertible Debentures’ (FCD’s) or ‘Partly Convertible Debentures’ (PCD’s) with or without buy back facilities. Fully convertible debentures are converted into equity shares after the lapse of a certain period specified at the time of issue of such debentures. PCD’s are converted into equity shares partly and the balance is not converted into equity.

The unconvertible part of the PCD is redeemed after the lapse of the specified period. A company may offer PCD’s with a buy back facility also, whereby; a mention is made in the application form that the portion of debenture which is not convertible into equity can be sold by its holder within a specified period at a predetermined (discounted) price.

Type # 8. Zero Interest Bonds / Debentures:

Zero interest bonds are an instrument recently introduced in India by some companies. It is usually a convertible debenture which yields no interest. The company does not pay any interest on such debentures. But the investor in a zero interest bond is compensated for the loss of interest through conversion of such bond into equity shares at a specified future date.

The issue of such debentures enables a company to service its equity in a better way as no interest is paid against such debentures and conversion of such bond into equity shares at a specified future date.

The issue of such debentures enables a company to service its equity in a better way as no interest is paid against such debentures and conversion takes place usually after the project starts bearing fruits. It also results in a reduction in the project cost to the extent of interest during the construction period.

Type # 9. Zero Coupon Bonds:

Another instrument which has recently become popular in India is the zero coupon bond (ZCB). Zero coupon bonds do not carry any interest but it is sold by the issuing company at deep discount from its eventual maturity value. The difference between the issue price and the maturity value represents the gain or interest earned by its investor.

Type # 10. First Debentures and Second Debentures:

From the view of priority in the payment of interest and repayment of the principal amount, the debentures may be either first debentures or second debentures, etc. The debentures which have to be paid back first or who have preference over other debentures in payment of interest or called first debentures and the debentures who rank after these are known as second debentures.

Type # 11. Guaranteed Debentures:

These are debentures or bonds on which the payment of interest and principal of .is guaranteed by third parties, generally, banks and Government, etc.

Type # 12. Collateral Debentures:

A company may issue debentures in favour of a lender of money, generally the banks and financial institutions, as a collateral, i.e., subsidiary or secondary, security for a loan raised by it. These debentures are called collateral debentures and these become effective only when the company makes a default in the repayment of the loan against which these have been issued.

Type # 13. Other Innovative Debt Instruments:

In the fast changing capital market scenario, the corporate sector has devised many other innovative debt instruments for raising funds from the market.

Some of these are outlined below:

(i) Equity Warrants:

The equity warrant is a paper attached to a bond or preferred stock that gives the holder the right to buy a fixed number of company’s equity shares at a predetermined price at a future date. The equity warrant increases the marketability of debt instruments.

When it is issued, it usually has no value but it becomes valuable when the market price of equity shares moves above the fixed price at which the investor is permitted to buy the equity shares.

(ii) Secured Premium Notes (SPNs):

The secured premium note is a tradable instrument with detachable warrant against which the holder gets equity shares after a fixed period of time.

(iii) Callable Bond:

A callable bond is a bond that can be called in and paid off by the issuer at a price, called the ‘call price’, stipulated in the bond contract. It gives the advantage to Issuer Company to call the existing bonds if the interest rates fall in the market below the bond’s coupon rate.

(iv) Floating/Variable or Adjustable Rate Bonds:

The rate of interest payable on these bonds varies periodically depending upon the market rate of interest payable on the gilt edged securities.

(v) Deep Discount Bonds (DDBs):

The deep discount bond does not carry any interest but it is sold by the issuer company at a deep discount from its eventual maturity (nominal) value. The Industrial Development Bank of India (IDBI) issued such DDBs for the first time in the Indian capital market at a price of Rs. 2,700 against the nominal value of Rs. 1 lakh payable after 25 years.

(vi) Inflation Adjusted Bonds (IABs):

These are the bonds on which both interest as well as principal is adjusted in line with the price level changes or the inflation rate.

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