Most investors consider convertible debentures to be a more lucrative investment option than fixed deposits. Generally, aspects of these debentures like – liquidity, higher yield and scope of capital appreciation, draws the most attention from the populace.
Following is a close look at this debt instrument, and everything it encompasses as an investment option.
Convertible debentures meaning can be described as a long-term debt instrument. Typically, a convertible debenture is issued by a company and can be converted into equity shares eventually.
Notably, the decision to convert debentures into equity shares lay with shareholders, and they are treated as the creditor or lenders. Regardless, in some cases, issuers may possess conversion rights.
These are unsecured bonds or loans, which means there is often no underlying collateral service as security. Generally, businesses issue such long-term debt instruments to avail tax-saving benefits. For instance, companies that issue convertible debentures are entitled to claim tax deductions on the amount of interest paid to investors.
It must be noted that convertible debentures yield a lower interest when compared to pure debt instruments. Such debentures can be exchanged for stocks at specific times; in turn, enabling bondholders to offset at least some risks involved with putting money in them.
These debentures are of two kinds, namely –
Details of these two types of convertible debentures are elucidated in the table below –
|Parameters||Fully Convertible Debentures||Partly Convertible Debentures|
|Definition||The value of these convertible debentures can be changed into the company’s equity shares.||Only some portion of the debentures would qualify for conversion into the company’s equity shares.|
|Capital base||Their conversion leads to higher equity capital.||Their conversion leads to lower equity capital.|
|Flexibility in terms of financing||They have a highly favourable debt-equity ratio.||They have a favourable debt-equity ratio.|
|Classification for calculation||They are classified as equity.||The convertible portion is classified as equity, whereas, the non-convertible part is classified as debt.|
|Ratio of conversion||The ratio is determined at the time of issuance of securities.||The ratio is determined when the securities are issued.|
|Suitability||Fully convertible debentures are suitable for companies which do not have an established track record.||Partly convertible debentures are suitable for those companies that have an established track record.|
|Popularity||They are highly popular among investors.||They are not very popular among investors.|
In a broader sense, a convertible debenture is a kind of hybrid security and hence manifests characteristics of both – debt and equity.
These are other prominent features of convertible debentures.
From a business point of view, these debentures are considered to be among the quickest and most feasible ways of raising funds. Companies issue debentures, and with the funds raised, they accelerate the growth and profitability of their venture.
The most popular benefits of convertible debentures for investors are as follows –
To gain a better picture of convertible debentures example, intending investors should make it a point to weigh in the debt-instruments limitations as well.
The most noteworthy drawbacks of convertible debentures as investment options include –
Investors should factor in these limitations while gauging the suitability of convertible debentures. Subsequently, they should develop strategies to hedge the associated risks and increase income through investment in this debt instrument.