Debenture - A bond which is not secured by any asset or collateral is known as a debenture. Debentures are mostly long term in nature and at times, the holder has an option of exchanging debentures for stocks of the issuing company. Debentures are of two types:
Convertible debenture - Convertible debentures are those which can be converted into company stocks. These types of debentures generally command a lower interest rate when compared with non convertible debentures.
Non convertible debenture - Non convertible debentures are those which cannot be converted into company stocks. These types of debentures generally command a higher interest rate when compared with convertible debentures.
Reducing Downside Risk
Convertible debentures help in reducing the risk involved as they are backed by the company’s assets. An increase in the stock prices leads to price appreciation. But in the case of a down trend, convertible debentures are better and decline more gradually when compared with non convertible debentures. Hence, in case of volatility in the markets, convertible debentures are a safer bet when compared with non convertible debentures.
Benefits to Issuers
One of the primary reasons for companies to issue convertible bonds is that there is a higher interest cost associated with them. They can take advantage of this by offering bond holders the option to convert them into company stocks. Convertible bonds are also associated with less risk and hence are more desirable for investors.
Value at Maturity
In case of a convertible bond, the realization maturity value may or may not be its redemption par value. It can either be lower or higher than the par value, depending on the market situation. In case of a conversion to company stocks, debenture holders are treated exactly the same as the company shareholders. This means they are either free to hold the securities or sell them in the open market.
Markets at Work
Once the convertible bonds are issued, their market value is decided depending on the interest rate, which is also dependent on market fluctuations. These are generally traded between 805 to 110% of the par value. Investors, in this situation, can take a lot of advantage; maximum benefit can be reaped when they are close to the underlying stock and they also experience appreciation of the value of the security.