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How Is Redemption of Debentures Calculated

16 Aug 2023

Loans are not limited to individuals. Companies also lean on debt occasionally to cover their liquidity issues. They do so through various means, one of which is debentures. Debentures are a type of debt instrument used by organizations in need of money to raise capital. Companies take debentures from investors, promising to repay the principal amount and interest at a fixed date.

Companies prefer issuing debentures as the cost of capital associated with issuing equity tends to be higher than that of debt. Moreover, since the redemption of debentures is a long-term obligation spanning ten years or more, the company has ample time to fulfil its commitments.

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If you have lent money to a company in the form of debentures, here are some things you need to know about their redemption process.

What is the redemption of debentures?

Redemption of debenture refers to the process of paying back the borrowed money to investors like you. When a company issues debentures, it sets a fixed time for repayment. At the maturity of the term, the company gives back the money to you.

How is the redemption of debentures calculated?

The debenture redemption amount can either match the debenture's face value, be more than the face value, or less than it. The company mentions the exact terms when issuing debentures and follows them at the time of redemption.

Here's how this works:

  1. At par: In this case, the redemption amount is the same as the debenture's face value.
  2. At premium: When companies opt for the premium, the redemption amount is higher than the debenture's face value. For example, if the debenture's face value is Rs 50, the redemption value could be Rs 60.
  3. At a discount: In this case, the redemption amount is lower than the debenture's face value. For instance, if the debenture's face value is Rs 80, the redemption value might be Rs 70.

Methods of redemption

Companies may choose from the following methods for the redemption of debentures:

  • Lump sum payment

This straightforward method involves paying the agreed amount on a predetermined date in a lump sum. The amount paid is decided based on the agreement at the time of issuance. In some cases, companies may also repay you before the maturity date.

  • Installment payments

Sometimes companies may not have enough capital to pay back the money in one lump sum payment. In this case, they may opt for installments. Companies typically pay annual installments in regular or irregular intervals as per the agreement when issuing the debentures. 

  • Conversion into shares or debentures

Tailored for convertible debentures, this approach enables you to switch your debentures into regular equity shares of the company or new debentures. The fresh debentures can carry the same coupon rate as the existing ones. Depending on the circumstances, they may also feature a different rate, which can be higher or lower than the original debenture. 

However, companies must indicate the term 'convertible debentures ' in their balance sheet if they choose this option. 

  • Open market purchase

Some companies may choose to buy debentures from the open market to eliminate the hassles of administrative complexities. This is usually done if the debenture units are traded on a regulated exchange. An open market purchase allows companies to capitalize on potential market discounts and reduce redemption costs.

  • Debenture redemption reserve

Also known as a sinking fund, the debenture redemption reserve option involves setting aside a minimum of 25% of a debenture's face value each year until maturity, as per the Indian Companies Act 1956. The company establishes this fund by setting aside a portion of its profits specifically to redeem debentures upon maturity. Its primary purpose is safeguarding the interests of debenture holders.   

  • Call and put option

Some companies issue debentures with either call or put options for redemption. Companies may also offer both options. The call option empowers companies to buy back their debentures at a predetermined price before or on the maturity date. Conversely, the put option grants you the right to sell your debentures back to the company at an agreed price before or on maturity.

To sum it up

Debentures play a crucial role as a means for companies to secure funds. Each method of redemption comes with its unique advantages and considerations, allowing companies to tailor their approach to their financial needs and goals.

 

Related Blogs: Differences Between Tangible And Intangible Assets | Difference Between ROIC and ROCE | Why companies that reduce debt outshine the market | What Us The Rule of 72

 

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