Redeemable debentures are fixed-income securities that provide investors with periodic interest payments. Due to their predetermined maturity dates, these debentures typically offer lower interest rates compared to other debt instruments.
In exchange for the funds, the issuing company pays interest to the investors at a certain fixed rate at regular intervals. These interest payments continue until the debentures mature.
What are the features of redeemable debentures?
Now that you are aware of the meaning of redeemable debentures, let us look at a few of their defining characteristics.
1.Predetermined maturity date
With redeemable debentures, the date on which they mature is pre-decided by the issuing company. On the maturity date, the issuer redeems the debentures by repaying the principal amount of investment to the debenture holders.
2.Fixed interest rate
Redeemable debentures come with a fixed rate of interest, which is announced at the time of issue itself. The interest on the investment amount is credited to the accounts of the debenture holders at the predetermined frequency.
3.Collateral
Redeemable debentures can either be secured or unsecured. In the case of secured debentures, the debt instruments would be backed by the assets of the issuing company. If the issuer defaults on payment of interest or the principal amount, the assets pledged as collateral will be liquidated. The resulting funds are then used to settle the dues to the debenture holders.
In the case of unsecured debentures, the debt instruments are not backed by any assets. If the company defaults on payments to debenture holders, the investors have little to no legal recourse.
4.Flexibility
Certain types of redeemable debentures give the issuing company the option to redeem them before the maturity date. However, such early redemptions are subject to certain conditions, which are often outlined in the debenture agreement.
How do redeemable debentures work?
As an investor, merely knowing the definition of redeemable debentures and their features is not enough. You must also know how they work. Let us look at a hypothetical example to understand the concept of redeemable debentures.
Assume ABC Limited is in the business of manufacturing automotive components. It requires funds to purchase specific machinery. The company decides to issue redeemable debentures to the public to raise capital.
According to the terms of the debenture agreement, the tenure of the debentures is 5 years, and the rate of interest is 9% per annum. The interest on the invested amount is payable every quarter.
Now, let us say that you choose to purchase Rs. 5 lakh worth of redeemable debentures. The company is obligated to pay interest of Rs. 11,250 every quarter until the stipulated maturity date. On the date of maturity, ABC Limited will repay your principal investment amount of Rs. 5 lakh.
What are the advantages of redeemable debentures?
Redeemable debentures are beneficial for both the issuing entity and the investors. Here is a quick overview of some of the key advantages of these debt instruments.
1.Steady income
Investors can enjoy a regular source of income by investing in redeemable debentures. Moreover, the assurance of repayment of the principal amount on maturity makes them a very attractive investment option.
2.Secure investment option
Secured redeemable debentures often have very low risk. Even if the issuing company defaults on repayment, debenture holders can rest assured of getting their principal amount back. The issuer can simply liquidate the assets pledged as collateral and use the proceeds to make repayments.
3.Convenient
Unlike raising funds through an Initial Public Offering (IPO), issuing redeemable debentures is a much easier and far more convenient option for companies. The process is less stringent and does not involve much regulatory approvals.
What are the disadvantages of redeemable debentures?
As with any investment option, redeemable debentures also have certain disadvantages. Knowing what they are can help you make well-informed investment decisions. Let us look at some of the key drawbacks of this investment option.
1.Low returns
The returns offered by redeemable debentures are generally low compared to market-linked investment options.
2.Default risk
Redeemable debentures will always have default risk, irrespective of whether they are secured or unsecured. However, you can reduce the risk by opting for debentures issued by companies with high credit ratings.
Differences between redeemable and irredeemable debentures
Redeemable and irredeemable debentures are two types of debt instruments that companies can issue. Here is a table outlining some of the key differences between the two.
Particulars |
Redeemable Debentures |
Irredeemable Debentures |
Maturity |
Have a fixed maturity date |
Perpetual with no fixed maturity date |
Redemption |
Redeemed on maturity |
Repayable only when the company is liquidated |
Flexibility |
Can be redeemed before the stipulated maturity date if the debenture agreement has the provisions |
No flexibility in terms of redemption or otherwise |
Conclusion
Redeemable debentures offer an easy and convenient way for companies to raise capital. The predetermined maturity dates and fixed interest payments make these debt instruments an attractive option for investors looking for a moderate-risk investment that offers stable returns.
