How to Invest in Debenture?

Trading in debentures

Debentures are a type of loan raised from the public by the corporate or government which are generally unsecured. However, debentures have a fixed rate of return hence make it a safe investment for investors. It is a document issued under the seal of the company.

Why does a company issue debentures?

From company’s point of view, raising capital through debentures is a good deal for them as debenture holders are not given any voting rights hence control is with the shareholders only. Time span of debentures is long thus company can take up the expansion plan. Interest paid on debentures is treated as an expense thus; lowering the income tax. Debentures are low cost funds as interest paid to debenture holders is less than the rate of dividend. Company may also raise capital through debenture in case it is overcapitalised.

Procedure to invest in debentures

The procedure for investment in debenture is same as that of a share. You need to log into your trading account (demat account) to buy or sell debentures or alternatively you can also request your broker to do the trading on your behalf for which a brokerage will be charged. Your bank account will be debited and demat account will be credited with the debentures of the equivalent amount. Interest will be credited to your account on the record date fixed by the company.

Buy or Sell

A debenture can lure an investor only when it will offer a yield higher than bank deposit rates and other investment options available in the market. Debentures are issued for a time period ranging from 1-5 years with a fixed interest rate. If you have purchased a debenture having a tenure of 4 years then you can either hold it for 4 years and also receive the interest otherwise it can be sold off at the exchanges.

Tips for investment

• Unsecured debentures have higher interest rate than secured debentures. If investment done is for regular income than one should opt for debentures with monthly or quarterly interest payout. If one has to just grow his wealth than he should opt for cumulative option. In cumulative option, the interest rate gets reinvested and it is paid at maturity.
• Credit rating of the debenture should be checked before investment. It is advisable to invest in high rated debentures only as the liquidity for the market of debentures is always a concern.
• Debentures can be considered as a better investment option than fixed deposit if they offer higher interest rates.
• High debt to equity ratio could mean that the company is highly leveraged hence issuance of debentures would lead to further increase in debt to equity ratio. Hence, the same should be analysed carefully before investing. Debt – Equity ratio is calculated by dividing Total Liabilities by Equity. Usually a low debt-equity ratio is very good for an Debenture investor, since the risk level is less with higher interest rates.
• If debentures are held till maturity then the interest earned would be treated as income and income tax would be levied on it. If it is sold within a year of purchase then short term capital gains are applicable. If debentures are encashed before its maturity but after a year then capital gain tax would be applicable.