Debentures, along with bonds, are one of the most popular debt instruments. Usually, when companies, and sometimes even the government, wishes to raise funds from the public, they issue debentures.
Debentures are referred to as a type of long term debt instrument that is not backed by any collateral. In other words, debentures are not secured or lack any kind of security. Along with bonds, debentures are one of the most popular debt instruments.
A convertible debenture is a kind of long-term debt which can be transformed into stock after a specific period of time. A convertible debenture is usually an unsecured bond or a loan as in there is no primary collateral interlinked to the debt.
Types of a Convertible Debenture:
- Fully Convertible Debenture: These are debentures in which the whole value of debentures can be converted into equity shares of the company.
- Partly Convertible Debenture: In this kind of debentures, only a part of the debentures will be eligible for conversion into equity shares.
Non-Convertible Debentures (NCD)
Non-convertible debentures (NCD) are fixed-income instruments, usually issued by high-rated companies in the form of a public issue to accumulate long-term capital appreciation. They offer relatively higher interest rates when compared to convertible debentures.
Types of NCDs
Following are the two kinds of non-convertible debentures:
1. Secured NCDs
Secured NCDs are considered safer of the two kinds as their issues are backed by the assets of the company. In the event of the company failing to pay on time, then the investors can recover their dues by liquidating the company’s assets. However, the interest offered on NCDs is low.
2. Unsecured NCDs
Unsecured NCDs are much riskier than the secured NCDs as the assets of the company do not back these. Hence, when the company defaults on its payment, the investors have no choice but to wait until they receive payments as there are no assets of the company to recover their dues. However, the interest rate offered on unsecured NCDs is higher than that of secured NCDs.
Difference between Convertible & Non-Convertible Debentures
1. Rate of Interest
The convertible debentures have a lower interest rate than non-convertible debentures since the holders have the advantage of converting them into equity shares.
The non-convertible debentures have a higher interest rate. However, these debentures are considered a little risky than convertible debentures and bonds.
2. Value at Maturity
The value of maturity of convertible debentures is dependent on the stock price of the company at that time, which means a high stock price will give higher returns while a low stock price will give low returns
The value of non-convertible debentures is fixed and hence they will receive fixed returns on maturity.
As stated above convertible debenture comes with lesser risk than non convertible debenture. There might be time when economy is in trouble and company is not able to pay interest or defaults in making payment of interest then by having convertible debenture you can convert your debenture into the shares of the company. Usually shares trade at higher value than the convertible debenture. After conversion, they act like any other shares and can be traded in the market for either profit or to cut losses.
Non convertible debenture hold higher risk as in the bad market this debenture might get default. Holders have only one choice as to hold it till maturity and if company defaults in making payment of debenture then this directly show the company is bankrupt. In this case, the holder can seize proportionate assets of the issuer.
4. Effect of Market Conditions
During bad market conditions, the holders of the convertible debentures have the option to convert into equity shares
During bad market conditions, the non-convertible debentures cannot be converted and can only be redeemed at maturity
This is one of the significant distinguishing factors between convertible and non-convertible debentures.
If you hold convertible debentures, you can enjoy either the status of being a creditor to the company or the owner of the company. Whereas, if you hold non-convertible debentures, your status will be the creditor of the company.