Difference between Shares and Debentures
If you are planning to invest in stocks and securities, then you should always remember to have a proper understanding of the market. Knowing the key concepts of stock markets will enable you to make wise investment decisions. One such aspect is to know the difference between shares and debentures. As a new investor, you must remember that you can start trading in stock markets, only after opening a trading account and demat account. A trusted stock broker can provide you with a free online demat and trading account in India.
How can a company raise funds for its capital requirements?
A company can raise funds for its business through:
- Equity instruments: These are known as shares. Once a company, listed in stock exchanges, offers its shares or stocks through Initial Purchase Offerings (IPOs), you get a chance to become part-owners of the company by purchasing the shares.These are known as shares. Once a company, listed in stock exchanges, offers its shares or stocks through Initial Purchase Offerings (IPOs), you get a chance to become part-owners of the company by purchasing the shares.
- Debt instruments: A company can also choose to fund its businesses through loans. A company can issue debentures, which are primarily debt instruments entailing regular interest payouts. Once you purchase debentures of a company, you become its creditor.A company can also choose to fund its businesses through loans. A company can issue debentures, which are primarily debt instruments entailing regular interest payouts. Once you purchase debentures of a company, you become its creditor.
Understanding shares of a company:
After purchasing shares of a company, you become part-owner and the ownership is directly linked with the number of shares in your possession. Apart from the profits that you can receive from trading in shares, you can also receive income from dividends. As a shareholder, you also receive certain rights such as the right to vote.
Types of shareholders:Generally, there are two types of stockholders:
- Common stockholder: These comprise the majority of a company’s stockholders. A common stockholder receives the right to vote and the benefit of receiving dividends.
- Preferred stockholder: While these stockholders do not have any voting rights, they are given priority in making repayments, if the company becomes bankrupt.
Understanding debentures of a company:
- These are primarily debt instruments with the objective of raising long-term loans for the company. Typically, debentures are backed by the creditworthiness of the issuing company.
- Unlike shares, ownership of debentures will not make you part-owner, nor will you receive benefits of dividends, or any voting rights. You are simply a creditor of the company, with the right to receive a fixed interest rate.
- You can purchase debentures either in the secondary market or when they are issued for the first time.
Types of debentures:There are two types of debentures being issued by companies:
- Convertible debentures: These debentures can be converted into stocks or shares at a future point of time.
- Non-convertible Debentures (NCDs): These don’t provide the option of being converted into stocks at any point of time. NCDs again can be of two types:
- Secured debentures: These are secured by some underlying assets of a company. Interest payouts in secured debentures is less when compared to unsecured debentures.
- Unsecured debentures: Also known as naked debentures, these are not secured by any company asset. These provide higher rates of interest vis-à-vis secured debentures.
Risks associated with investments in Non-convertible Debentures:Before making investments in NCDs, you must always consider the risk factors. Typically, NCDs have three types of associated risks:
- Inflationary risks: These arise because of the rise of prices. Inflationary risks can eat into the returns received as interest payouts.
- Interest rate risk: Sudden cuts in interest rates can negatively impact debenture holders.
- Default risk: This is a risk in the case of the company defaulting on its obligation to provide interest payouts.
To counteract the associated risks with investments in NCDs you must always check the past performance of the company along with conducting market research about its financial position. You can also check the credit ratings by Investment Information and Credit Rating Agency (ICRA).
Difference between shares and debentures:You can refer to the chart given below to know the differences between the two financial instruments
|Definition||These represent equity||These represent debt|
|Returns from investments||You receive dividends||You receive interest payouts|
|Access to voting rights||Yes||No|
|Convertibility features||Cannot be converted into debentures||Convertible debentures can be converted into stocks|
|Types||Common shareholders and preferred shareholders||Convertible and Non-convertible Debentures|
|Representatives||Stockholders are part-owners||Debenture holders are creditors|
|Risk of investment||Have high market risks because of being exposed to market volatility||Have lower risks because of lower exposure to market volatility|
|Returns||Provide high returns||Provide moderate to low returns|
Thus, you can select to invest either in shares or debentures in consonance with your financial objectives and risk appetite. If you want a low risk instrument, with fixed interest payouts, you can select to invest in debentures. Conversely, you can invest in stocks if you are willing to take higher risks with a long-term objective of wealth creation. For investing both in shares and debentures, you are required to open a trading account and demat account. Selecting a reliable and trusted stock broker can provide you access to the best trading account in India.