Debenture Investing In Nepal: What Is Debenture?

Debentures are a great way for investors to secure a safer investment return and to diversify their investment portfolios.

And with a lot of different companies already offering corporate debentures here in Nepal, let’s take a look at what debentures are, how they are used, who issues them, who buys them and interest rates on them.

What is debenture?

Debentures are a type of unsecured debt security issued by a company or organization to investors in order to raise money. 

In simple terms, you loan the money to a company and they promise to pay you a pre-determined interest rate for the period and the full balance upon the end of the period. You receive a certificate as evidence of the debt which is called the debenture. 

What are the advantages of debentures?

For investors, debentures are also extremely useful because the interest rate that they can get is generally higher than the interest rates on their bank deposits. It also generates a consistent (fixed interest) cash flow that they can use as one of their reliable income streams. 

For companies, debentures are a very convenient means of raising financial resources for budding companies. It is a great way for them to secure short to mid-term financing to meet their working capital requirements or to fund capital intensive projects. 

They are also advantageous for companies since they carry lower interest rates and longer repayment dates as compared to other types of loans and debt instruments.

What are the disadvantages of investing in debentures?

The main point to understand is that not all debentures offer good investments. The higher the rate of return, the more risky the investment and the lower the return, the safer the investment. 

When considering the risks and rewards of investing in a debenture, it is critical to weigh the risks and rewards of the debentures against those of other, probably more provident, investments.

There are two key risks with debentures.

  1. Interest rate risk: When interest rates rise, the value of your debentures will fall as other investors will not be interested in a lower yield debt investment. On the other hand, if interest rates fall, the value of your debentures will rise as they offer a better return than what’s available in the market.  
  2. Issuer risk: One of the key disadvantages to debentures is that they are not backed by any kind of collateral. Instead, they are backed solely by the faith and credit of the issuing party. In case the issuer of the debenture is not able to meet its payment due to a business downturn, it can be catastrophic. This is why higher risk companies issue debentures at a higher interest rate so as to make it worth the risk for investors. A recent high profile equivalent would be the Ever Grande bond default. 

What are the current interest rates on debentures in Nepal?

In recent years, a lot of commercial A class banks, development banks and finance companies have issued corporate debentures with varying interest rates.

FAQ: Debenture

When is the interest on bonds and debentures paid?

The interest is paid on a quarterly basis, i.e. every 3 months till maturity. 

The amount is directly credited to the bank account linked to your Demat account. 

At maturity, the entire principal is paid out along with any interest accrued.

How can I buy bonds or debentures in Nepal?

There are two ways, you can buy bonds or debentures:

  • In the IPO (initial public offering) when they’re first issued. Minimum investment is 25,000 (25 units at Rs 1,000) or 
  • In the secondary market, NEPSE using your broker or online using your TMS (Trade Management System).

Can debentures be traded on the stock exchange?

Yes, debentures are traded on the stock exchange, which in our case is the NEPSE. 

What is the difference between a bond and a debenture?

The key difference between a bond and a debenture is that a bond is a secured loan, that is to say, there is an asset secured against the loan. Whereas, a debenture is not secured against any asset of the issuer. 

You can think of bonds like a house loan which is secured on the house and debentures like a credit card. In case, you default on the house loan, they can sell your house and recoup their loan, but in the case of credit cards, they do not have an asset to sell.

Another key difference is that if a company that issued both bonds and debentures goes into liquidation (bankrupt), the bondholders get paid first by selling the asset backing the bond and the proceeds from the sale of the company’s assets go to debenture holders and other creditors. 

Note that shareholders of the company have the last claim so they bear the most risk.

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