What is redemption of debentures?
A debenture is a type of unsecured loan that companies or governments raise from investors. Debentures, derived from the Latin word debere, carry certain terms and conditions, such as payment schedule, maturity date, and interest rate, which are set by the issuer.
So, what is the redemption of debentures? Imagine you are a debenture holder. Redemption simply means that the company is repaying all it owes to you. This will discharge the company from its liability towards you. A company can redeem your debentures either at the maturity date or even earlier as per the date mentioned in the prospectus.
Debenture redemptions can involve payments of a large sum of money. This is why companies usually keep aside some part of their profits to create a debenture redemption reserve (DRR) account. Companies use this account for the redemption of debentures.
Debentures are removed from the balance sheet once they have been redeemed by the companies, whether on or before the maturity date. This lowers the overall amount of debt and obligations companies have on their books.
Debenture redemption characteristics
If you are a debenture holder, you should carefully study the prospectus since it contains all of the terms and conditions relating to debenture redemption. The company issuing the debentures to you must adhere to all these conditions while redeeming your debentures.
Value of the debenture at the time of redemption
The value of debentures at the time of redemption can be:
If your debentures are redeemed ‘at par’, the redemption value is equal to the face value of the debentures. The face value of debentures in India is usually Rs 100. At par means the company will pay Rs 100 back to the debenture holder.
At a premium:
if your debentures are redeemed at a premium, the redemption value is higher than the face value of the debentures. In such a case, if the face value of a debenture is Rs 100, debenture holders will receive a value higher than Rs 100.
At a discount:
if your debentures are redeemed at a discount, the redemption value is lower than the face value of the debentures. In such cases, the redemption value will be less than Rs 100, assuming the face value of the debenture is Rs 100.
Methods of redemption of debentures
There are several methods by which a company can redeem the debentures you hold:
Lump sum payment at maturity
The simplest way to redeem debentures is through a lump sum payment. When a company chooses this method, you are paid a fixed sum at the maturity date. Dates of payment are mentioned in the prospectus, though companies can pay you earlier than maturity if agreed upon at the time of issue.
Lump sum payment can help companies be prepared ahead of the time, since they know the obligation date and the amount that needs to be paid. Nonetheless, you should keep track of a company’s financials so that they have an idea of whether the company will be able to pay on time.
Some issuers may redeem your debentures in periodic instalments, usually annually. It is similar to how one repays a loan in multiple instalments. This method ensures that companies do not have to meet a large payment obligation at the time of maturity.
Converting debentures into equity
Some debentures come with an option to be converted into equity of the issuing company. Such debentures are called convertible debentures. Companies can choose to convert these debentures into equity at par, at a discount, or at a premium to the face value of the debenture.
Debenture redemption reserve
As stated earlier, companies create a debenture redemption reserve, which is a mandatory requirement under the Indian Companies Act 1956. The main objective of this fund is to safeguard the interest of investors.
Purchasing from the open market
Some debentures are listed on stock exchanges and hence, are tradable in the secondary market. In some cases, companies tend to purchase these debentures from holders like you in the open market. If these debentures are available at a discount, the companies also benefit from acquiring them.
Q. What is the most common way to redeem debentures?
The most common and simple way to redeem redemptions is through a lump sum payment. Conversion into equity is also opted for by several companies as they do not have to make cash payments and only need to dilute equity.
Q. What is Debenture Redemption Reserve (DRR)?
As per the Companies Act 1956, companies issuing debentures have to create a DRR and maintain 25 percent of the outstanding debenture capital in this account. It is also called a sinking fund. A company can reinvest the fund in this reserve to earn extra interest on the capital.
Q. What is the average tenure of debentures?
Debentures are usually issued for the medium to long term. Most debentures do not have a maturity period beyond 10 years. But some, especially those issued by large infra projects, can have maturity periods of up to 30 years.
Trading refers to buying or selling either shares of companies or derivatives such as futures and options.
Capital expenditures, also known as capex, are expenditures a company makes with the purpose of acquiring, maintaining, or upgrading long-term assets. Revenue expenditures, also called operational expenses, or opex, refer to expenses that a company incurs to maintain its day-to-day business operations.