What is a Redeemable Debenture?
A debenture is a debt instrument that a company uses to raise capital by borrowing money from the public. A redeemable debenture issue is a legal certificate that mentions the investor’s investment amount, interest payment, the schedule of payments, and the repayment date of principal amount. The repayment date distinguishes the redeemable debentures from others, i.e. the company has to repay the loan at a predetermined date to the debenture holder. Because of this clause, companies attract more investors for redeemable debentures. Also, it gives an assurance of payments to investors.
Redeemable debentures are fixed-income instruments where investors receive periodic payments in the form of interest. Moreover, the interest rate of these debentures is comparatively lower than others because they have set repayment dates.
A company can redeem debentures either –
- At Par – Repayment of debenture happens at the face value of the debenture. The face value is the value the company sets at the time of issuing them.
- At Premium – Repayment of debenture happens at a higher amount than the initial issued amount.
Features of Redeemable Debentures
The following are the features of redeemable debentures –
- Written Promise: It comes with a written promise with an assurance of paying back the loan money with interest.
- Repayment: The primary feature of this debt instrument is repayment. But all debentures come with a specific date by which the issuer must fulfill the repayment amount. However, how the repayment amount is paid can vary. The issuer can choose to release all its redeemable debentures in a single lump sum. Or else the issuer can also opt for periodic payments during the tenure.
- Redemption Amount: The issuer can redeem the debentures either at their face value or premium (paying higher than face value). The legal contract includes all these details. Therefore, investors must weigh these options before investing.
How do Redeemable Debentures Work?
Redeemable debentures are an attractive option for corporates and governments to raise capital for a specific purpose. When they issue debentures, they offer coupon rates for investors along with a promise to repay at a specific date in the future. Also, when repaying the principal amount, the issuer can choose to make lump sum payments or instalments. Moreover, in case of corporate debentures, the company makes the interest payments ahead of the shareholder’s dividend.
For instance, a company decides to take a loan by issuing debentures. The company will make a legal certificate that binds the issuer and the borrower. This legal certificate contains all the details of the instrument and payments. It also outlines how and when the company will repay the sum of money.
Suppose Company A issues redeemable debentures on 1st December 2015 and as per the issue certificate, the repayment date is on 1st December 2020. Therefore, the company has to make the principal repayment on or after the expiration of the mentioned period.
Advantages and Disadvantages of Redeemable Debentures
The following are the advantages –
- Fixed Payments: Debenture holders can secure a fixed stream of payments by investing in these instruments. Unlike a market-linked instrument, the issuer is legally bound to make fixed payments at regular intervals to the debenture holders per the contract terms.
- Secure: This instrument is not affected by market volatility. The issuer promises to make regular payments and pay the principal at a predetermined date. Thus, this can dilute the overall risk in an aggressive portfolio.
- Easy Financing: Companies and government can conveniently raise finance through redeemable debentures. Also, it attracts investors because of the repayment promise feature.
The following are the disadvantages –
- Low Income: These debentures offer low coupon rates compared to other fixed-income instruments. Thus, it can reduce the investor’s earning potential.
- No voting rights: These debenture holders have no voting rights in the company’s management and decisions.
- Financial Burden: If the issuer (company) is not able to make profits, then these instruments become a financial burden for the company. Because they are bound to pay the principal amount even after the maturity date. Thus, when the company faces losses, it pays debenture holders from its own pockets.
Frequently Asked Questions
No, redeemable debentures are long-term liabilities because they are to be repaid in future.
Yes, any company can issue redeemable debentures.
The redeemable debentures are shown under the long-term liabilities on the balance sheet.
A callable bond is a redeemable debt security because it can be redeemed early by the issuer before its maturity at their discretion.
Yes, a loan is a redeemable debt because the borrower promises to pay back the lender at the end of the tenure.