Within the framework of investments, shares, and debentures are crucial instruments used by companies to raise capital. The company may require funds for various purposes, such as expansion, R&D, or advertising a new line of products or services. Whatever the reason may be, the two prominent ways to go about this include either making their shares available for purchase or borrowing debt.
Both types of securities are representative of ownership. But they differ in their intrinsic characteristics, risks involved, and profits. It is important that you understand these differences to become financially wiser and aim for higher returns.
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Shares represent a section of ownership of a company. If you purchase a share, you become a shareholder of the company. Post-purchase, you become a part-owner and can lay a claim on the company’s assets and profits. Being a shareholder, you enjoy certain voting rights and are a participant in the decision-making processes of the company.
Debentures, on the other hand, are a type of debt instrument. If you become a debenture holder for a company, it means that the company owes you some debt. They are liable to pay regular interest to their holders. You, as a debenture holder, do not receive any voting rights or shares of profits. In case of liquidation, paying you back is a top priority.
Shares: As any investor is aware, shares come with a higher risk and a potentially higher return. That’s because the market is volatile and share prices can fluctuate. If the capital appreciates, the shareholders can make huge profits. But they also suffer the risk of losing money as well. However, over an extended period, investing in equities has historically yielded positive results. Shares are best for investors who have a high-risk tolerance.
Debentures: Debentures are usually a more stable source of income for debt holders and have risk compared to shares. The interest is a fixed amount that is paid at regular intervals, thus producing a steady stream of cash flow. However, the returns generated through debentures are mostly lower than those of shares. Overall, debentures are highly suitable for risk-averse investors wishing for security over high-profit margins.
While shares allow for the transfer of ownership, debenture owners are simply creditors who fund the company with needed capital. In other words, debentures are a liability to the company. Debentures are generally issued for a fixed time period and can be the right choice for investors with a medium-risk profile. Several companies have either raised or plan on raising heaps of money through non-convertible debentures (NCDs).