What are Redeemable Debentures: Meaning, Formula & Examples

I. Introduction

Debentures are a popular choice among many investors and the fact that companies pay regular interest to debentures makes them particularly attractive. However, if you are interested in redeemable debentures, you must understand what debentures are and their redemption process. Today we will discuss everything you need to know about redeemable debentures, including its meaning, formula with an example, and more.

An overview of redeemable debentures

A debenture is a type of debt instrument that is not backed by any collateral. It usually has a term greater than 10 years. Redeemable debentures are typically fixed-income debentures that come with a fixed maturity date. They are redeemed once the debenture reaches its maturity date.

Importance in financial planning

Redeemable debentures play an important role in financial planning for both the company as well as every individual investor. For companies, it is an easy and convenient way to raise capital. On the other hand, debentures come with fixed maturity dates and interest payments making them excellent options for debt investors.

II. Understanding redeemable debentures

Debentures are a good option if you are looking for a fixed-income source through debt investment. But before we dive deep and learn about the formula to calculate redeemable debentures, and its pros and cons, let’s learn about the basics of redeemable debentures.

Definition of redeemable debentures

Redeemable debentures refer to a type of debt investment vehicle that comes with a predetermined redemption date and regular fixed-interest payouts. These types of debt investments have a fixed maturity date that is predetermined by the company. They mention a date specifying when the debentures get the company to redeem the promised debt investment returns to the investors. There are several ways a company can redeem its debentures. They include lump-sum payments on a predetermined date, payment in annual investments, debenture redemption reserve, conversion into shares, call-and-put options, and more.

Key characteristics

When planning to invest in redeemable debentures, you must learn about their key features. Here are some key features of redeemable debentures that make them stand out from the rest.

● Written promise: All redeemable debentures come with a written promise or formal written guarantee. The company thus promises in writing to return all the debts and loans taken from debenture investors.

● Coupon rate: Another interesting characteristic of redeemable debentures is the interest rate. The coupon rate of every debenture is determined by the interest rate that the company will pay to its investors or debenture holders. The coupon rate can be fixed or floating based on the company’s debt repayment policies.

● Maturity date: The maturity date plays a crucial role in redeemable debentures. It indicates a fixed date on which the company must pay out all its redeemable debentures to its debenture holders.

● Credit rating: A company’s credit rating is technically the debentures’ credit rating on which the amount of interest will be paid to debenture holders. Usually, a credit rating agency evaluates the creditworthiness of a debenture-offering company or government issues. Therefore, it offers essential insights into the potential risks associated with debt investment.

Read More: What is the difference between shares and debentures?

III. Formula for redeemable debentures

There are several formulas that can be used to evaluate redeemable debentures. Below, we will discuss the most popular method or formula of redeemable debentures that most debt investors use.

Present value of debentures formula

When a debenture (bond or debt investment) falls under the redeemable category, the present value of debentures can be determined by estimating its future cash flow and after that discounting the estimated future cash flow at an appropriate discounting rate or capitalization rate. Therefore, the present value of the debenture formula refers to the estimated future cash flow discounted at a fair or appropriate capitalization or discounting rate.

Calculation of redemption value

Redeemable debentures refer to the debenture investment plans that come with a redemption date in which the company will redeem all the debt to its debenture holders. Here is a formula widely used to calculate the debenture the company is going to redeem after the maturity period-

Debenture redemption (or redeemable debenture returns) = Face value of the company + Premium (if promised any).

IV. Example of redeemable debentures

The best way to understand redeemable debentures and how it is calculated is by learning through examples. So here’s one to help you through.

Step-by-step example

Let’s assume that ABC Company issues redeemable debentures. Here are its details:

ABC Ltd.

Face Value: I= Rs 20 lakhs

Interest: 5%

Repayment date: 1 August 2025

Redemption premium: 2%

Thus, the Redemption Amount is:

20,00,000 + (2% of 20,00,000) = Redemption Amount

= 20,00,000 + 40,000

= 20,40,000

ABC Ltd. will pay Rs 20.4 lakhs to its debenture holders at the maturity period.

Analysis of results

The premium amount of debenture issued by ABC Ltd is Rs 20 lakhs with an interest of 5% and a premium of 2%. The redemption amount is calculated by adding the principal amount to the redemption premium of the principal amount. The principal amount is Rs 20,00,000 and so the redemption amount or 2% of  Rs 20,00,000 is Rs 40,000. That makes Rs 20,40,000 the final debenture repayment amount.

Read More: What Are Non-Current Liabilities? Definition

V. Advantages and disadvantages

Redeemable debentures are one of the most preferred debt instruments. These debt instruments have several advantages and disadvantages for investors. Below, we will discuss some of the most essential pros and cons in detail.

Benefits of redeemable debentures

As a debt investor, you can get several benefits from redeemable debentures. Here are some common benefits you can get by investing in redeemable debentures in India:

● Fixed income: Redeemable debentures are known for offering a fixed income source to its investors. Debenture holders can get a constant flow of income by investing in such debt investment vehicles. Unlike market-linked investment plans debentures require the company to pay a fixed amount regularly to the debt holders agreed upon in a contract.

● Simple financial solution: Another essential advantage of redeemable debentures is a simple financial solution. These types of debt investment help simplify the financial needs of both investors and the company. For example, debentures help companies collect capital as they come with an investment return policy. Also, the promise to offer regular payout on a regular basis attracts many investors.

● Secure investment vehicle: Lastly, redeemable debentures are one of the most secure debt investments as they come with a solid financial stability record. It is primarily because redeemable debentures come with a guaranteed repayment policy as the company has issued a repayment certificate stating the time of issuing the date of repayment and method of repayment by which the company will compensate the principal amount and interest to the investors.

Potential drawbacks

Besides numerous benefits, redeemable debentures come with several drawbacks or limitations that you must know about before investing.

● Lower-income: Although redeemable debentures come with fixed-income, its features still offer a very low rate of income when compared with other market-linked fixed securities.

● Creditworthiness: Despite the investment return guarantee, credit of the company plays a determining role in the outcome. The creditors may need to go through much red tape if the debenture issuer fails to fulfill the promise of repayment within the maturity date.

● No voting rights: Unlike, market-linked equities redeemable debentures do not have any voting rights to participate in any internal decision-making process.

● Financial burden on companies: Although redeemable debentures are an easy way to collect capital, they create an unwanted financial burden on the company as they have to pay debentures within the maturity date using its funds even if the company is going through tremendous financial loss.

VI. Conclusion

Redeemable debentures are a type of debt investment or vehicle that garnered a debt payout with regular interest. Therefore a lot of debt investors prefer to invest in redeemable debentures as a fixed income source. 

Recap of key points

Redeemable debentures are the debt investment scheme that comes with a predetermined redemption date or maturity date, by which the issuer has agreed to make the repayment. The method of repayment can vary depending on the company’s debentures repayment plan. Also, redeemable debenture schemes have their unique pros and cons for both companies and investors that one should keep in mind before investing.

Final thoughts on redeemable debentures

Redeemable debentures are excellent financial investment or debt investment vehicles that come with guaranteed repayment with regular returns. However, they can have several risks that you must consider before investing in these schemes.

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