Basics of Stock Market - Beginner

Difference between Debentures and Shares

Investors in the share market need to be familiarized with a few terms that can make it easier to make investment decisions. This article will cover stock/stock and debentures. There are two main ways a company can raise funds for expansion and growth: equity and debt.

If a company chooses the equity route, it will issue shares to the public. Shareholders get to be part of the company's growth story. Another route is debt. This allows a company to borrow money from the public. The loan promises to pay regular interest. Debt issues debentures to the public. Those who purchase debentures are called creditors.

What is a share?

You become the owner of the company if you purchase shares. Your ownership is proportional to how many shares you have. You can vote, receive dividends, and sell any shares you own to anyone at any time.

Preferential share and common share are the two types. Common stockholders can receive dividends and voting rights, while preferred stockholders do not have voting rights. Priority in repayment is given to preferred stockholders if the company goes bankrupt.

What are debentures?

A type of debt instrument that allows a company to raise a long-term loan is called Debenture. It is not secured and is only backed by the creditworthiness the issuer. Because they are creditors, not shareholders like those who own shares, debenture holders don't have voting rights.

Both convertible and non-convertible debentures can be converted. Convertible debentures allow you to convert the debentures into shares at will, whereas non-convertible (NCD) debentures are not allowed. The interest rate on unsecured NCDs are comparatively lower than those offered by secured NCDs. Based on creditworthiness, credit agencies assign ratings to companies issuing debentures.

ICRA has provided a definition of credit ratings. This rating should be verified before you purchase NCD.

  • AAA - The highest level of safety
  • AA - High level of safety
  • A - Adequate level of safety
  • BBB- Moderate level of safety
  • BB - Moderate Risk of default
  • B - High Risk of default
  • C - High risk of default
  • D- Companies that are in default will likely be in default within the next few days

There are risks in NCD investments

There are risks associated with debentures, including inflationary risk, interest rate volatility and default risk. In the event of inflationary risk, the interest rate provided by the debentures might not be sufficient to beat inflation. Interest rate risk is a sudden change in interest rates that could result in loss for debenture holders. If the issuing company has financial difficulties, you could be subject to default risk.

Important points to remember when buying NCD

  • 1. 1.Check the credit rating of your company
  • 2. Make sure to do thorough research on the financial strength of the company.
  • 3. Review the past performance of this company

How do I buy shares and debentures?

Shares can be purchased when a company goes public with an IPO (Initial Public Offering). You can also trade shares in secondary markets after the company is listed on the exchange. You can either buy debentures immediately after they are issued or in the secondary market. To buy shares or debentures, you will need a trading and demat account.

Difference between shares or debentures

Sr. NoFeaturesSharesDebentures
1DefinitionRepresents ownership/equityRepresents debt
3Voting rightsYesNo
4ConvertibilityNot convertible into debenturesYou can convert some debentures to equity
6Shareholders/Debenture HoldersAre there owners?Are creditors
7TypesStocks of common and preferred stockConvertible and not-convertible

You can choose between equity and debentures depending on your needs. Your risk tolerance is also important. You can get regular interest and safety with debentures. If you're willing to take high risk and receive high returns, you should invest in shares. Before you invest, make sure that you have a good understanding of the differences between debentures and shares.

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