A company or the Government possesses several means of raising finance to funds its various activities. Speaking broadly, companies usually employ two ways to raise finance – namely, stocks or debt. The former is deemed as owned capital, while the latter is borrowed, meaning it carries a repayment clause inherently.
If drilled down further, debts come in several forms as well, both secured and unsecured. Debentures belong to the unsecured category, meaning they do not require collateral. One can further classify this debt instrument into types based on unique characteristics. A redeemable debenture is one such type.
In this article
What is a Redeemable Debenture?
One of the most vital features of a debenture is that it has to be repaid. However, not all debentures come with a specific repayment date. Issuers of debentures, in general, can repay such debts any time before winding up entirely. But, per redeemable debenture meaning, it is not the case.
Redeemable debentures carry a specific repayment date. The issuer is bound to repay such loan by a predetermined date to the original lender or debenture holder. Due to this clause, companies can attract more investors with a redeemable debenture. That’s because investors are more assured of getting repaid.
Apart from this, a redeemable debt shares the basic features of a fixed-income instrument. That means, investors receive periodic payments in the form of interest, and such device does not follow market volatility. However, since a redeemable debenture carries a set repayment date, the interest they generate is comparatively less than standard debentures in most cases.
What are the Features of Redeemable Debentures?
Over the last few years, the emergence of digital platforms has encouraged scores of individuals to invest in securities through instruments like mutual funds. It has expanded the range of options where individuals can mobilise their funds, allowing for more diverse portfolios.
People can also invest in redeemable debentures similarly. However, prior to doing so, it might be beneficial to familiarise oneself with this debt instrument. That way, individuals can make sounder decisions and optimise their financial standing.
Some of the features of redeemable debentures are –
The primary feature that distinguishes this debt instrument is repayment. In general, all such debentures come with a specified date by which the issuer must repay in full the borrowed amount.
However, how the amount is repaid can vary. An issuer can choose to release all its redeemable debentures with a single lump-sum payment. Or else, a company can opt for periodical payments or instalments during the lifetime of such loan.
Another crucial aspect of a redeemable debt is the amount at which it is redeemed. A company or issuer can redeem at par its lot of such debentures. On the other hand, it can also choose to redeem at a premium. That means paying a price that is higher than the face value of such debentures.
Following is a redeemable debenture example for better understanding.
There are two companies, ABC and XYZ. The following table shows the hypothetical details of redeemable debentures they issued on 1st April 2020.
|Particulars||Company ABC||Company XYZ|
|Value||Rs.10 lakh||Rs.10 lakh|
|Date of repayment||1st April 2025||1st May 2025|
As per terms of issuance, Company ABC is to redeem the debt at a premium of 1%, while Company XYZ will redeem at par. Both terms dictate a lump-sum payment.
Therefore, on 1st April 2025, Company ABC pays Rs.10,10,000 in order to discharge its liability. Company XYZ, on the other hand, repays Rs.10 lakh on 1st May 2025.
When investing in such a debt instrument, it is crucial to learn of the repayment terms in detail. That way, individuals can weigh-in their options and optimise their benefits.
What are the Advantages of Redeemable Debentures?
Investors and issuers enjoy the following benefits when it comes to this debt instrument –
- Fixed income
By investing in redeemable debentures, entities can secure a fixed stream of income. Unlike a market-linked instrument, the issuer is legally bound to disburse a fixed amount at regular intervals to creditors.
A redeemable debenture does not track market volatility. Also, it comes with a promise of repayment by a predetermined date. Hence, it dilutes the overall risk of an aggressive portfolio.
- Easy financing option
Redeemable debentures are a convenient source of finance for companies and the Government. In fact, most government securities come with a fixed tenure, like 5 years or 10 years. It attracts investors owing to its repayment promise.
What are the Disadvantages of Redeemable Debentures?
The following are a couple of the demerits of redeemable debentures –
- Low income
Typically, redeemable debentures offer a lower coupon rate compared to other fixed-income instruments. Ergo, it can bring down the earning potential of a portfolio. It can also imply inflationary risk if the interest rate does not measure up to inflation.
Despite repayment promise, in the end, it boils down to the issuer’s creditworthiness. Creditors need to jump through a lot of bureaucratic hoops if the issuer is unable to make good its promise of repayment by a specified date.
Difference between Redeemable and Irredeemable Debentures
The primary distinction between these two debt instruments is regarding the tenure of repayment. With irredeemable debentures, an issuer is not liable to repay within any specific date. That’s why it is also known as a perpetual debenture. Issuers can repay such debt after a long period or when it is being liquidated. That is not the case with redeemable debentures.
Understanding these basics can help individuals to chalk out their investment planning more efficiently. They can then create a portfolio that is more in line with their investment objectives.