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Learn how convertible debentures combine fixed interest with an option to convert into equity.
Convertible debentures are hybrid financial instruments that combine the characteristics of debt and equity. Investors receive fixed interest like a regular bond, along with an option to convert the debenture into shares of the issuing company at a later date. This combination of fixed interest and potential equity participation provides both steady income and the possibility of capital appreciation.
Convertible debentures are long-term debt instruments issued by a company that pay periodic interest but can be converted into equity shares after a predetermined period. They are typically unsecured and rely on the creditworthiness of the issuer.
Key points:
They start as debt and can convert into equity.
Conversion terms are pre-set at the time of issuance.
Interest rates are typically lower than non-convertible debentures; the potential value of conversion is an additional feature.
Issuers use them to raise capital without immediate equity dilution.
The working mechanism of convertible debentures involves three stages:
Issuance Stage
The company issues convertible debentures to investors. Terms such as coupon rate, conversion ratio, conversion date, and maturity date are disclosed in advance.
Interest Payment Stage
Investors receive fixed or floating coupon payments during the life of the debenture.
Conversion or Redemption Stage
On the conversion date, investors can convert debentures into shares based on the predetermined conversion ratio.
If the investor chooses not to convert (in some structures), the company repays the principal amount at maturity.
Conversion occurs based on the predetermined conversion ratio and conversion price, and may depend on prevailing share prices.
Here are some key features to note:
Fixed Interest Payments
Investors earn periodic interest until conversion.
Conversion Option
A built-in feature that allows conversion into equity shares at a preset rate.
Lower Coupon Rate
Interest rates are typically lower than those of non-convertible debentures.
Unsecured Nature
Convertible debentures are generally not backed by collateral.
Dilution Post-Conversion
Conversion increases the company’s outstanding shares, potentially diluting existing shareholders.
Here are the main categories based on how and when conversion takes place:
The entire debenture amount converts into equity shares after the conversion period.
A portion of the debenture converts to shares; the remaining part is repaid as debt.
Conversion is compulsory upon maturity or a specific event.
Investors have the choice to convert or redeem based on market conditions.
Valuing convertible debentures requires assessing both the debt component and the equity option value.
Key factors influencing valuation:
Company’s creditworthiness
Market interest rates
Share price movements
Conversion ratio and conversion price
Time to maturity or conversion
Expected volatility in the stock
Convertible debentures are valued higher when the issuing company’s share price is expected to rise significantly, giving investors stronger conversion benefits.
A few key advantages include the following:
Lower interest rate burden on the issuer
Opportunity for investors to convert debt into equity
Reduced financing cost for companies
Provides fixed interest with the potential for equity participation
Less dilution at the time of issue (occurs only upon conversion)
Can help companies raise capital even during volatile markets
Some important limitations to consider are:
Equity dilution after conversion
Lower coupon rates for investors compared to non-convertible debentures
Conversion value depends heavily on market performance
Potential mispricing due to complex valuation
Adds future uncertainty for companies regarding capital structure
In India, convertible debentures are governed by SEBI regulations. Many public and private companies issue them to raise long-term capital. Key aspects include:
Mandatory disclosures on conversion terms
Ratings by credit rating agencies
Listing on recognised stock exchanges
Detailed interest payment and conversion schedules
Convertible debentures are popular among NBFCs, infrastructure companies, and high-growth firms seeking flexible financing.
Convertible debentures blend the security of fixed-income instruments with the growth potential of equity. They allow investors to earn steady interest while retaining the option to convert into shares, offering flexibility across market conditions. For companies, they provide a cost-effective capital-raising method with delayed equity dilution.
Important points to Note:
Convertible debentures combine fixed returns with equity upside.
They help issuers reduce interest costs and postpone dilution.
Suitable for investors seeking income plus long-term growth potential.
Conversion terms and issuer strength must be assessed carefully.
Can be included in a diversified investment portfolio.
This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.
Convertible debentures are interest-bearing debt instruments that give holders the option to convert their debenture units into equity shares of the issuing company after a defined period.
Types include fully convertible debentures, partly convertible debentures, mandatory convertible debentures, and optional convertible debentures, each differing in conversion terms and timing.
Convertible debentures offer the right to convert debt into equity, whereas non-convertible debentures remain purely debt instruments and typically offer higher interest to compensate for the lack of conversion features.
Convertible debentures may be issued by listed and unlisted companies, including corporates and NBFCs, subject to SEBI regulations and applicable disclosure requirements.
Key benefits include initial capital protection through interest payments, lower early-stage risk, and the opportunity to participate in equity appreciation through conversion.
Risks include dependence on market conditions for meaningful conversion gains, relatively lower interest rates compared with non-convertible options, and the possibility of shareholder dilution when conversion occurs.
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