Convertible Debentures; Everything You Need to Know

There exists a wide range of investment options that an individual can consider. While evaluating various investment options, debentures may emerge as a compelling alternative to more conventional choices, such as fixed deposits, or even shares. Among many types of debentures, convertible debentures offer attractive features and benefits. But what is convertible debenture? Continue reading to learn more about this debt instrument to make an informed choice while you create your portfolio.

What is a Convertible Debenture?

Convertible debentures are hybrid financial products that offer the features and benefits of both debt and equity investments. Convertible Debentures are long-term debt instruments. These debentures can be converted into equity shares after a specific time period. The decision as to whether or not to convert debentures into shares lies with the debenture holders.

Convertible debentures are unsecured bonds or loans. There are no underlying collaterals attached as security. The bondholders receive regular interest income via coupon payments till their maturity. After that, they can be converted into equity shares.

What are the Features of Convertible Debentures?

Since a convertible debenture functions as a hybrid security, it showcases features of both debt and equity. You can find a list of the salient features of convertible debentures below:

Conversion Price:

This is the price at which an ordinary share is issued and then allotted to a debenture holder. It depends on various factors like the current book value, market price, etc. The higher the conversion price, the lower the addition to the capital base.

Rate of Conversion:

This ratio is an indication of the number of equity shares that can be received against a convertible bond.

Conversion Quantum:

This figure refers to the number of debentures that are to be converted and is usually expressed as a percentage of the face value.

Coupon Payment:

A convertible debentures value depends on an issuer’s credit quality and the interest rates prevailing at that time. When a break-even analysis is undertaken, it proves useful in paring the coupon payouts against the dividends earned via common shares.

Convertible Value:

A convertible debenture has a value that is solely based on the investor’s right to receive equity shares. To arrive at this value, all you have to do is multiply the conversion ratio by the market price of each equity share.

Timing:

For a convertible debenture, timing usually ranges between a year from the date of allotment to 5 years.

Market Price:

This price is the amount decided upon as per the investment and conversion value of the debenture. Simply put, it is the value attached to the convertible debenture by the market.

What are the Different Types of Convertible Debentures?

Convertible debentures are broadly categorized into two types; fully convertible debentures and partly convertible debentures. The two differ from each other according to the parameters listed below:

Meaning:

While fully convertible debentures can be converted into a company’s equity shares, with partly convertible debentures only a portion qualify for such conversion.

Capital:

Fully convertible debentures provide higher equity capital whereas partly convertible debentures offer lower equity capital.

Classification:

Fully convertible debentures are classified as equity whereas partly convertible debentures only classify as equity to the extent of the portion that is convertible. The rest is classified as debt.

Suitability:

Fully convertible debentures are apt for companies that do not have an established track record. Partly convertible debentures are better suited for companies that do have an established track record.

Popularity:

Fully convertible debentures are highly popular amongst investors whereas the same is not the case for partly convertible debentures.

What are the Benefits of Investing in Convertible Debentures?

From a business-based perspective, convertible debentures are considered to be the fastest and easiest way of raising funds. When companies issue debentures, they use the funds raised to speed up the growth and boost the profitability of their enterprise.

Generally speaking, the benefits of investing in convertible debentures are as follows:

• You can receive a fixed rate and also participate in stock price appraisal.
• You can redeem your bonds at maturity, which is especially useful if an issuer’s stock price falls.
• If you hold a convertible debenture, you get paid prior to other stockholders if the company has to liquidate itself.
• Since a convertible debenture is a hybrid instrument, you get to enjoy fixed-interest payouts along with the option of converting your loan to equity when the company is faring well.

Although there are several advantages, investing in convertible debentures can also leave you dealing with certain limitations. For instance, they offer a lower interest rate and are subject to the ramifications of the issuing company defaulting.

Overall, you must consider the limitations and hedge against the risks associated with convertible debentures to enjoy the advantages they bestow. Make sure to do your research and invest as per your financial goals and standing.