Shares and Debentures

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shares and debentures
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Shares and debentures are securities in which invest to put their money in use. Companies issue shares and debentures to meet their financial requirements and people purchase them to get returns as dividends and interests. Shares are a part f the capital whereas debentures are more like loans. The debentures holders are repaid their principal amount after a specific time and this isn’t in the case of shareholders. Shareholders become the owners of the company and debenture holders act like lenders.

Debenture holders get a fixed amount as interest irrespective of the company’s profit or loss. Shareholders get dividends only when the company is stable and earns a profit. No company is solely based on shares or debentures. They have a ratio to be maintained like 80% shares and 20% debentures to have a balance. Companies strictly follow their debt-equity ratio to cover their debts by equity. This also adds to the reputation and credit ratings of the company in the financial market.

If a company is dissolving or closing then the debenture holders have an upper-hand. The companies are bound to pay the principal amount of the debenture holder to be it by selling their assets. But this is not so in case of the shareholders, they only get the principal amounts if the company has something left with itself after the payment of all its debts. Since shareholders are the owners they have to bear the losses along with the company.

Even though investing in shares is risky it is where most people invest because higher the risk, higher is the return. If you can bear the risk and wait for returns you should go for investing in shares because with time it will give you maximum return. But if you can’t take high risk then you can go for debentures as you will get a fixed amount as interest.

So now before going into shares and debentures let us first know about the financial market. It is the place where the buyers and sellers meet and buying and selling of securities takes place. This market can be virtual or physical. The financial market consists of two markets, money market and the capital market. Let us first talk about the money market.

The money market is governed and regulated by the Reserve Bank of India (RBI). The instruments of this market are issued for a short-term that means they have a maturity period not more than one year. This market is again divided into two categories, Organised and Unorganised. In the organised money market, you will find instruments like Call Money (issued by banks), Treasury Bills (issued by the government to meet short-term financial requirements), Certificate of Deposits (like an agreement between the investor and the bank), Commercial Papers (issued by companies with good credit ratings), Cash Management Bills (issued to meet short-term needs like paying short-term bills) etc.

This market is highly liquid and involves over the counter transactions. The unorganised money market isn’t governed and included Liquid Adjustment Facilities (LAF). The returns in this market are low as the maturity is short. People who want quick returns can invest in this market. The only purpose of this market is to provide for short-term debt requirements.

The capital market is also governed by the RBI. Here the companies raise funds to meet their long-term financial needs, that is, over one year. This market is also divided into two categories, Primary market also known as the new issue market and Secondary market. In the primary market, shares are issued for the first time. Here the unlisted companies can issue shares for the first time and this process is known as Initial Public Offering (IPO). The funds are raised with a long-term objective.

Companies can also raise funds through mediators like underwriters. Underwriters are usually banks that take the risk for the company. They can also be institutions with good financial strength. They buy shares from the company in bulk and then sell them to the investors at a premium. The secondary market is the place where already listed companies issue securities or the existing securities are traded. You will find shares, debentures, derivatives, foreign exchanges and commodities in the capital market. Now let us talk about shares and debentures in particular.

Shares

shares and debentures
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Most businesses start as private companies. They are owned by the people who set them up, by a group of backers or families. And many businesses stay in private hands for generations or centuries. Companies issue shares to raise money. They do so to finance company expansion, new development or to move into overseas markets. At this point, they have the option of floating in the stock market.

In floatation, outside investors are allowed to buy a share of the company. Shares are also known as equity. When a company floats its shares in the stock market, the shares are sold t a certain price, which represents the value placed on the business.

When you buy a share of a company you become a part of the ownership of the company. The bigger the investment you make, the bigger will be your part in the company. If you are new in the stock market then it is important to have the basic knowledge before investing.

Buying shares of a company can be exciting. As a shareholder, you will have a stake in the company you have invested in and you will have the right to vote, support or criticise the directors’ decisions. If a company performs well, you will receive an amount in the form of dividend payouts. And in long-term, there is the potential for further returns from the growth in the share’s value though, of course, they can fall as well.

There are two types of shares –

  • Preference shares – these are those shares which are given preference as regards to payment of dividend and repayment of capital. Their holders receive preferential treatment over common stakeholders in the event of liquidation and even dividends are paid but do not enjoy normal voting rights. In case of winding up or if the company goes bankrupt then after the payment of liabilities are done, the preference shareholders are paid and then the equity shareholders.
  • Equity shares – they are ordinary shares. These shares do not enjoy any preference regarding the payment of dividends and repayment of capital. They are given a dividend at a fluctuating rate. The decisions regarding the dividend are taken by the company itself and there is no guarantee of a regular dividend. Some companies do not give dividends even if they earn huge profits. The equity shareholders have the privilege that they get voting rights in the General Meeting. When we talk about shares it is generally equity shares.

What affects the share price?

share prices
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The stock market is dependent on supply and demand. For any share dealing to take place, there must be investors willing to sell their holding and buyers wanting to buy them. The investors’ sentiments move share prices. The market is a collective view of a company.

What a company does, how it behaves, how it interacts with the customers, its reputation, all of these matter in the market and will be reflected in the share price. The company’s profits, cash flows are the indicators of their financial health.

You should never invest without the advice of a stockbroker if you do then always research the company you are planning to invest in by looking at its website and reading their annual reports. There are other factors also that can move a company’s share price called the corporate actions, such as acquisitions and mergers.

How can you earn through shares?

There are mainly two ways to earn money from shares. First, you can purchase the shares at a price that you believe will increase over time. This is called return, capital gain or growth. As a company grows and becomes more profitable, there are chances of their share price to rise. Second, you may receive dividend payouts. Dividends are nothing but the distribution of the company’s profit.

Young and growing businesses are likely to have low profits and they usually re-invest the profits to keep growing instead of distributing them as dividends. So such companies may pay little or no dividend for some time. But they have the potential for the share prices to rise as the business expansion is considerable.

A matures and bigger business, on the other hand, has less scope for dramatic growth and offer a steady and reliable stream of significant profits, which can be paid out as a dividend. The potential for dramatic price rise is less but so are the chances of price fall.
The past performance of any company is never a guarantee or indication of performance.

A share’s price can fall as well as rise and investors always need to be aware of the risk of losing more than the sum they have invested. It is up to you to decide what company you want to invest in, do you want a steady income or is a capital to gain your goal.

Who can invest?

There are two categories of shareholders – private investors and institutional investors. Private investors are individual shareholders. They don’t make up a large percentage of the value of the market. The government privatisations of the 80s and 90s have created many new shareholders because of the scheme where employees can also buy the company’s shares. Institutional investors are companies whose aim is to invest in other companies.

They include pension companies, who invest in building employees’ pension scheme.
New share floatation is available to institutional investors in the first instance. Once the share issue is completed, the private investors can then invest and trade the shares of the company.

Shares aren’t the right investment for everyone. They aren’t risk-free investments so you should put only that much money which you can afford to lose. There are no investor compensation funds to refund any losses if the company’s share value decreases or goes bust. The amount you are going to spend on shares should be the money you can afford to put away for at least five years.

One of the advantages of shares is that they can be sold easily, which puts them in the category of liquid assets. But the downside is you could sell at the worst time and end up losing money. If you are uncomfortable with such risk then you must talk to a financial adviser before investing.

Risk and reward

You might have thought about becoming an investor in shares, but been put off by the apparent complexity of the stock market, by the risk involved or simply because you don’t know where to start.

There are various advantages of investing in shares, but your portfolio should be properly diversified. You can easily do this by spreading your investment capital across different asset classes. This will reduce the risk of too much exposure to just one asset. An idol portfolio would be balanced across four main asset classes – shares (also called equities), government and corporate bonds, property and cash.

Multi-asset funds offer a full spread of all these listed asset types. For first-time investors as well as the seasoned ones, a fund can provide a far more diversified investment than a single company’s shareholding ever can.

What rights will share ownership give you?

Share ownership means exactly what the name suggests, that is, you own a share of the company you buy shares of. This gives you a say in how the business is managed. And it also entitles you to get a share of the business’s profit and success.

If you own a small fraction of the company that you might not be listened very keenly by the management .but a pension fund with a 20% stake can expect the firm’s undivided attention. Small shareholders get to express their views in the Annual General Meeting. Usually, small shareholders don’t make an impact but they may attract sufficient support to influence company policy.

What are the pitfalls?

First of all, it is important to understand the difference between savings and investment.
When you put your money in a bank savings account, you know you will get a certain level of return and your money is safe. Putting your money aside in a savings account is a sensible way to save for short-term goals like a holiday or to cover you for a rainy day.

The drawback of savings is that your money is very unlikely to grow at a rate to keep up with the inflation. So, even if your balance is increasing, in real terms it is shrinking.

Now as we have seen, share ownership offers potential for both income and healthy capital gain. However, nothing is certain in business. The small companies which appear to offer the potential of rapid growth can also crash and burn and even the most stable and strong companies’ can fall dramatically in value or fail. So, predicting the future fate of businesses isn’t easy.

Buying and selling shares

It is often believed that trading in the stock market requires a lot of experience and loads of money. But this isn’t true; you can start with quite a modest amount, and with the right support and advice you can build up your experience as you go. You can also join investment clubs, where you share the risk and learn from each other.

To buy shares, you simply tell your broker how many shares you want to buy or how much money you wish to invest. Your order could be at the best price available now or you can specify a price limit above which you don’t want to buy. The same applies when you want to sell shares. The market’s trading hours are from 8:00 to 16:30, Monday to Friday, excluding Bank Holidays.

What does a share look like?

Earlier when there was no internet, shares used to come in the form of a paper share certificate. Nowadays, paper shares are rare. If you own the shares, the details will be held by the company registrar directly. You can register to check your holding online. If you invest through some stockbroker then your shares will be held by them in a nominee account on your behalf. The nominee shareholders have less privilege than direct shareholders.

Not having a paper certificate and having an online record removes the worry of the share being lost or stolen and it also means that you don’t have to physically send the shares when you are selling them.

When to sell shares?

It is impossible to time things so that you sell out exactly at the top of the market so you shouldn’t try it also. One of the best options is to set a target price at which you would be prepared to sell. With a trading account, you can set a sale limit and the shares are sold automatically when the price limit is reached. You can also set a stop-loss limit which automatically sells your shares at the next available price when the price falls to a certain point.

Another strategy is top-slicing, this involves selling sufficient shares to recoup the initial investment, whilst leaving the gains invested with the hope that the share price will rise.

What is the cost of selling and buying?

There are three categories of cost in buying and selling of shares.

  • Taxes and levies
    All the UK share purchases are taxed with 0.5% stamp duty. Another less onerous charge is a levy of 1 euro on each transaction over 10, 000 euro, to fund the panel on takeovers and mergers.
  • Dealing commission
    Investors pay stockbrokers a commission for carrying out their purchase or sale. This can be either a percentage value of the shares being bought or sold or a flat fee per deal. Stockbrokers are required to publish there in a way that doesn’t require a degree in economics to work out. Some tariffs charge you less the more you deal. Make sure that to meet the dealing threshold for a particular tariff, otherwise it can be an unnecessary expense.
  • Account fees
    It is reasonable when there is a cost associated with having an account-based dealing facility. It is a quarterly subscription that provides for the ongoing account administration sometimes with extra facilities. With other accounts, there are no direct fees but the cost id affectively charged along with the commission.

The main thing is to understand what you are paying and what you will be getting for it. Talk to other investors those who deal with brokers, check-out surveys and talk to brokers directly. Do they speak your language and you feel comfortable talking to them? After all, you are entrusting a considerable amount from your earnings to them so you must get along.

I think this is all you need to know about shares if you are a beginner as investors. Once you enter into the market with a good broker you will get the idea. And with the time you will be having a great experience. It might happen that after a while you won’t need a broker or become one. If you want to invest in shares I would say start with a small amount but start early because money requires time to grow. You can’t expect a gain in just a day or a month; you will have to be patient.

Debentures

debenture certificate
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Debentures are the securities used by the government and companies to issue loans. These loans are issued at a fixed interest depending on the reputation of the company. When companies need to borrow money to expand them they issue debentures. They are written instruments of debt that companies issue under their common seal. These certificates are issued to the public as a contract of repayment of the money borrowed from them.

They are for a fixed period at a fixed interest rate which can be paid half-yearly or annually. Debentures are issued to the public at large like the shares. They are the most common way for large companies to borrow money. Now let us see the features of this security so that you can understand it better.

Features

  • Debentures are an instrument of debts, that means the debenture holder are the creditors of the company.
  • They are a certificate of debt, with the date of redemption and amount of repayment mentioned on it. This certificate is issued under the seal of the company known as the debenture deed.
  • They have a fixed rate of interest, which can be paid annually or half-yearly.
  • The debenture holders do not get any voting rights in the company. Because they aren’t the owners of the company they are a lender to the company.
  • The interest payable to the debenture holders are a charge against the profit of the company. So interests are paid even if there are losses.

Advantages of debentures

  • The companies can get their required funds without diluting their equities. Debentures are a form of debts so the equity of the companies remains unchanged.
  • The interests paid are a charge against profit for the company. This means it is a tax-deductive expense and it useful while tax planning.
  • They encourage long-term planning and funding. And compared to other forms of lending debentures are the cheapest.
  • Debenture holders bear very little risk since their loan is secured and the interest is payable even in case of loss.
  • At the time of inflation, debentures are the preferred instrument to raise finds since interest rates are fixed.

Disadvantages of debentures

  • The interest payable is a financial burden for the companies. It is payable even when the company faces loss.
  • Issuing debentures helps a company trade on equity but it also makes the company dependent on debts. A skewed debt-equity ratio isn’t good for a company’s financial health.
  • Redemption of debentures is a situation of cash outflow for the company which can imbalance its liquidity.
  • During the depression, profits are declining and debentures can prove to be very expensive due to fixed interest rates.

You can see that the demerits of debentures are just the opposite of its merits. This explains that it has equal advantages and disadvantages. So before investing into debentures be sure about these points.

Types of debentures

There are several types of debentures that a company can issue based on tenure, securities, convertibility etc.

  • Secured debentures – these debentures are secured against the assets of the company. A charge is created on such an asset in case of default in repayment of these debentures. In case the company doesn’t have enough funds to repay such debentures, the said asset will be sold to pay the loan. The charge may be fixed or floating.
  • Unsecured debentures – these debentures aren’t secured by any charge against the assets of a company. Such debentures aren’t issued by the companies in India.
  • Redeemable debentures – these debentures are payable at the expiry of their term, that is, they are payable at the end of a specific period. They are paid either in lump-sum or in instalments. These debentures can be redeemable at par, premium or at a discount.
  • Irredeemable debentures – these debentures are perpetual. There is no fixed date at which they become payable. They are payable when the company goes into liquidation. Or they can also be redeemed after an unspecified long time interval.
  • Fully convertible debentures – these debentures can be converted into equity shares at the option of the debenture holder after a fixed period. So if the holder wishes that after a specified time interval all his debentures will be converted into shares then he/she will become a shareholder.
  • Partly convertible debentures – the debenture holders are given the option to partially convert their debentures into equity shares. If the holder opts for this conversion, he/she will be both a creditor and shareholder to the company.
  • Non-convertible debentures – these debentures do not have the option to be converted into shares or any kind of equity. They will remain as debentures till their maturity date.

They are the most common type of debentures.

Why debentures?

Sometimes, the funds raised by the issue of shares are not enough to meet the financial needs of a company for the long run. In such cases, the companies choose to raise long-term funds through debentures. And investors choose debentures since the risk involved in debentures is much less than the risk in case of shares. The debenture holders are given a fixed amount of interest irrespective of the company’s profit or loss. It forms a great source of income.

The present scenario in India

In the last few years, the capital market of India has evolved at a much faster rate, the reasons are the launch of new instruments and the modifications in the old technologies. Presently, debentures prove to be a contributor to support the financial needs of the corporate sector. The Companies Act doesn’t provide for an exhaustive definition of debentures but has an inclusive definition.

According to the definition of debenture given in section 2(30) of the Companies Act 2013, debentures includes debenture stocks, bonds or any other instruments of a company evidencing to debt, whether constituting a charge on the assets of the company or not’. This section proves that a company can issue bonds and debentures which are an instrument of debt, which can be secured or unsecured by the way of creating a charge on the assets of the company.

Shares Vs Debentures

Both shares and debentures are a popular choice in the market. Let us talk about some of the major difference between them both.

  • Ownership of capital – capital raised through shares allows the shareholders to be the owners. Raising capital through debentures doesn’t give ownership to the debenture holders.
  • Role in the company – shareholders are like the owners of the company and have voting rights. Debenture holders are the creditors of the company.
  • Types – shares are basically of two types. Debentures are of seven types.
  • Forms of return – shareholders get dividends depending on the profits of the company. Debenture holders get interest.
  • Payments of return – dividends need to be paid to the shareholders only in case of a profit of the company. Interest is to be paid to the debenture holders irrespective of the profit or loss of the company.
  • Deduction from the net profit – when dividends are paid to the shareholders the profit earned is reduced. The interest payment is an expense to the company and is, therefore, reduced from other revenues to get the net profit of the company.
  • Conversion – shares cannot be converted into debentures. Some debentures can be converted into shares.
  • Trust deed – there is no trust deed for share allocation. But trust deed must be executed between both the parties while the issuance of debentures.
  • Transfer of ownership – share are non-divisible and non-transferable. Debentures are freely transferable.
  • Mortgage – the assets of the company cannot be mortgaged in place of the shareholders. The assets of the company can be mortgaged in favour of the debenture holders.
  • Shares are the owned capital of the company, whereas debentures are to raise the debt of the company. To issue debentures there is no need for any backing or underlying asset, but sheer reputation in the market. Investors are more interested in how well the company is in paying the interests regularly. Share capital is raised through the stocks and shares from the market. Before putting the money into the company’s shares the investor has to go through the books of accounts, prospective growth area of the company.
  • Risk – many investors invest in the debentures of a company as they carry lesser market-driven risk and promise a fixed income regularly in the form of interest. On the other hand, shares attract investors who don’t just foresee the value or growth of the company but also are ready to take the risk. The interest rates also remain fixed over the time it has been taken for. However, shares can give a higher profit only subject to the market risk.
  • The ratio between share capital and debt of the company – the debt should be capable of covering the equity. It signifies that the company has good cash management and debt-handling capacity. It also signifies how much of the share capital can be leveraged to raise debt from the market.
  • The government, as well as companies, float debentures in the market to raise money for their financial and other long-term requirements. The interest is fixed for the predetermined period for which the money is lent. Shares can be issued by a company only that too if it is a public company, that is, listed on the national stock exchanges of the country. A company can raise money only when there are more buyers in the market for its stock than the sellers.

Both forms of capital have their advantages and disadvantages. Stakeholders and investors should do their research well and decide not just their risk appetite but also the financial growth and capacity of the business they want to invest in. Debentures and shares both form an integral part of the company’s capital. You must study how different types of companies and industries function to increase or reduce the ratio between these depending on their requirements.

Investing your money in shares, debentures or any or any other instrument is a good idea to make use of your money. Investing is much better than keeping your money idea for years. The investment will lead your money to grow and give you returns. Savings is also important but too much of savings is of no use. Invest the amount which you can let go for a while and earn from it. This is how money works; you will have to invest it to get more of it.

Also just putting your money anywhere and saying it to be an investment is not the right thing. You will have to make proper decisions and settlements to make a proper investment. Start with a small amount to get the idea and then put your money to use. The choice of the instrument to invest doesn’t depend on the instrument but it depends on the investor and his/her expectations. If someone is looking for investing money for less than a year he/she will go for the money market.

If someone is looking to invest their money for long-term usually more than five years and are ready to keep this amount untouched for the period then they will go for the capital market. In the capital market, if the investor is looking for a fixed income for a predetermined time then he/she will go for debentures. Similarly, if an investor is capable of taking a risk and being a part of a company then he/she will go for shares.

And after the choice of instrument, one must do proper research about the company. You will be giving your money to a company so doing proper research is important. You must know everything about the company and the annual report of the company can help you with this. The annual report of a company included the report of directors of the company, auditor’s report, balance sheet, profit and loss account, income statement, cash flow statement etc. which are enough to give you a picture of the company.

Also, you can talk to people who invest regularly and to some brokers who can also give you good ideas for dealing. If you can invest in the right place at the right time you can expect good returns from your investment. And investment can be the easiest way to get income for you.