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Strategic Management and Corporate Finance · Sources of Corporate Funding

Debentures and Term Loans: Types, Features and Differences

Updated 11 October 2026 · Fact-checked

Debentures are debt instruments a company issues to the public or investors, acknowledging a loan and promising interest and repayment. Term loans are borrowings from banks or financial institutions repaid over a fixed period. To answer exam questions, define the source, list features, types, advantages and limits, then apply them to the facts.

Understand Debt Instruments: Debentures and Term Loans

A company needs long-term money for plants, expansion and working capital. It can raise this by selling shares (equity) or by borrowing (debt). This topic covers the main long-term debt sources.

A debenture is an instrument that acknowledges a debt. The company promises to pay a fixed rate of interest and to repay the principal on a set date. Debenture holders are creditors, not owners. They get no vote in general meetings and no share in profit beyond interest. Section 2(30) of the Companies Act, 2013 defines debentures inclusively. The term includes debenture stock, bonds and any other instrument of a company evidencing a debt, whether or not they create a charge on the company's assets. The list is not exhaustive.

Debentures can be classified in several ways. By security: secured (backed by a charge on assets) and unsecured. By tenure: redeemable (repaid on a set date or within a stated period). By convertibility: non-convertible (NCDs), fully convertible and partly convertible into equity. By registration: registered (holder's name is on the company's register) and bearer. Other types are zero-coupon (issued at a discount, repaid at face value), floating rate (interest linked to a benchmark) and secured premium notes.

Most debentures are issued as redeemable instruments with a stated redemption period. Under Section 71 of the Companies Act, 2013 and Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014, a company may also issue debentures that are redeemable on a contingency or on winding up, or perpetual debentures. This is allowed provided the issue is not otherwise invalid and the Rules are complied with. Section 71 also requires a debenture trustee for public offers and a debenture redemption reserve where applicable. In an exam answer, state the general rule, mention the exception with its conditions, and check the current provisions before you quote details.

In practice, the word bond is used for debt instruments issued by government, public sector bodies and large corporates, usually with a longer tenure. The two are close in meaning. A common distinction in textbooks is that debentures are often issued by companies and may be secured on assets, while bonds are often unsecured and carry the issuer's general credit. Treat this as a usage difference, not a strict legal one.

A term loan is a loan from a bank or financial institution for a fixed period, usually for projects such as plant, machinery or expansion. It has a repayment schedule, a stated interest rate, a security (often a charge on fixed assets) and loan covenants. Banks sanction it after appraising the project. An external commercial borrowing (ECB) is a loan raised by an Indian entity from a recognised non-resident lender, such as foreign banks, in foreign currency or rupees. It is governed by FEMA and RBI rules on eligible borrowers, lenders, end-use, maturity and cost. Check the current RBI framework for the route and limits before you quote figures.

Key rules to remember

Interest on debenture
Interest = Face value × Coupon rate × Time
Interest is calculated on face value, not issue price. Use it for annual or part-year interest.
Issue price of a debenture
Issue price = Face value − Discount (or + Premium)
Redemption is usually at face value unless a redemption premium is stated.
Post-tax cost of debt
Kd = Interest rate × (1 − Tax rate)
Interest is tax deductible, so debt is cheaper than its stated rate after tax.
Equated annual instalment of a term loan
Instalment = Loan amount ÷ Present value annuity factor
Each instalment covers both interest and part of the principal. Compute the annuity factor at the loan's interest rate over the number of repayment periods given in the question.

How to solve Debt Instruments: Debentures and Term Loans questions

Use this order for any descriptive question on debentures, bonds, term loans or ECB.

  1. 1Read the verb: describe, distinguish, explain features, or advise. It sets the shape of your answer.
  2. 2Define the instrument in one or two lines and state the nature: creditor relationship, fixed return, repayment.
  3. 3List the types or features under clear sub-heads, such as security, convertibility, redemption and registration.
  4. 4Add the legal or regulatory frame in plain words: Companies Act, 2013, SEBI for listed issues, RBI and FEMA for ECB.
  5. 5Give advantages and limitations, covering cost, control, tax, risk and obligation to pay.
  6. 6Apply it to the facts: company size, project, currency earnings, listing status.
  7. 7Conclude with a recommendation or a one-line summary that answers the question asked.

Quickest way: Four-box recall: Nature, Types, Pros, Cons

When to use it: Use when you have little time or must write a short note on any debt source.

  1. Draw four mental boxes: Nature, Types, Pros, Cons.
  2. Fill Nature with who lends, what is promised and what security backs it.
  3. Fill Types with the standard classifications for that source.
  4. Fill Pros with cost, tax shield and no dilution of control.
  5. Fill Cons with fixed payment burden, covenants and risk of default.
  6. Add one line on regulation, then one line applying the facts.

Common mistakes in Debt Instruments: Debentures and Term Loans

  • Calling debenture holders owners or giving them voting rights in general meetings.

    Debentures are confused with shares because both are issued by the company.

    Fix: Write that under Section 71(2) a company cannot issue debentures carrying voting rights, and that holders are creditors who receive interest whether or not there is profit.

  • Saying all debentures are secured.

    Students link debentures with a charge on assets.

    Fix: State that debentures may be secured or unsecured, and say that security is a feature of the issue terms.

  • Treating debentures and bonds as legally different instruments.

    Textbooks stress usage differences.

    Fix: Say the Act's definition includes bonds, and present the differences as common usage.

  • Calculating interest on issue price instead of face value.

    A discount or premium in the problem distracts the student.

    Fix: Interest always runs on face value at the coupon rate.

  • Writing ECB as any foreign borrowing without mentioning FEMA or RBI rules.

    The regulatory frame feels like detail.

    Fix: Mention eligible borrower, recognised lender, end-use, minimum maturity and cost limits are set by RBI under FEMA, and check the current framework.

  • Ignoring tax when comparing the cost of debt with equity.

    The pre-tax interest rate is quoted in the question.

    Fix: Apply Kd = rate × (1 − tax) and note that dividends are not a deductible expense.

Worked examples

Example 1

Sunrise Textiles Ltd issues 10,000 debentures of ₹1,000 each at a 9% coupon, issued at ₹950. The tax rate is 25%. Find the annual interest and the post-tax coupon cost on face value. Comment on whether this is the true cost of the debentures.

Show the solution
  1. Face value total = 10,000 × ₹1,000 = ₹1,00,00,000.
  2. Annual interest = ₹1,00,00,000 × 9% = ₹9,00,000. The issue price of ₹950 does not change it.
  3. Tax saving = ₹9,00,000 × 25% = ₹2,25,000.
  4. Post-tax interest = ₹9,00,000 − ₹2,25,000 = ₹6,75,000.
  5. Post-tax coupon rate on face value = 9% × (1 − 0.25) = 6.75%.
  6. This 6.75% is only the coupon cost on face value. It is not the effective cost of debt (Kd).
  7. Net proceeds = 10,000 × ₹950 = ₹95,00,000. Post-tax interest on net proceeds = ₹6,75,000 ÷ ₹95,00,000 = approximately 7.1%, which is already higher than 6.75%.
  8. The discount of ₹5,00,000 (₹1,00,00,000 − ₹95,00,000) is repaid at redemption but not received at issue. It adds further to the cost. The full effective cost needs the tenure and the redemption amount, which are not given here.

Answer: Annual interest is ₹9,00,000; post-tax interest is ₹6,75,000, or 6.75% on face value. This is the post-tax coupon rate only. The effective cost on net proceeds of ₹95,00,000 is higher (about 7.1% before counting the discount), because the interest is spread over a smaller sum and the discount adds to the cost.

Example 2

Bharat Engineering Ltd, an unlisted manufacturer with rupee revenues, needs ₹50 crore for a new plant. Advise on a term loan versus non-convertible debentures.

Show the solution
  1. State the nature: a term loan is a negotiated bank or institution loan with appraisal, a repayment schedule, security and covenants. NCDs are debt securities with fixed interest, issued to investors, with no equity conversion.
  2. Compare features: a term loan offers quick, flexible terms with a single lender. NCDs reach many investors but need rating, a trustee, disclosures and compliance with the Companies Act, 2013 and, if listed or publicly offered, SEBI rules.
  3. Advantages of both: interest is tax deductible and there is no dilution of control.
  4. Limits of both: fixed payment obligation, security charge and risk of default.
  5. Apply the facts: revenue is in rupees, so a domestic rupee source avoids exchange risk. An unlisted company may find a term loan simpler. NCDs may suit if it can bear issue costs and wants longer tenure.
  6. Note ECB as an alternative only if it is eligible and can manage currency risk.

Answer: A term loan is the simpler and quicker route for Bharat Engineering. NCDs are viable if it can meet rating and compliance requirements and wants market funding. Either way, the company must service fixed interest and provide security.

Exam tips

  • Answers are written and case-based, so always tie features to the facts given rather than listing generic points.
  • For distinction questions, use a two-column layout with at least four points: nature, holder status, security, return and tenure.
  • Write ECB answers around the regulator: FEMA, RBI, eligible borrower and lender, end-use and cost. Do not quote limits you are unsure of.
  • Show the interest-on-face-value and post-tax cost steps clearly in any numerical part, as marks go for method.

Practice questions from Sources of Corporate Funding

Debt Instruments: Debentures and Term Loans in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Debt Instruments: Debentures and Term Loans: frequently asked questions

What is the difference between debentures and bonds?

Both are debt instruments. In common usage, debentures are issued by companies and are often secured on assets, while bonds are issued by government, public bodies and large corporates and are often unsecured. The Companies Act, 2013 definition of debentures includes bonds, so the difference is mostly practical.

What are the main types of debentures?

By security: secured and unsecured. By convertibility: non-convertible, partly convertible and fully convertible. By registration: registered and bearer. Zero-coupon and floating rate debentures are other common types. Most debentures are redeemable. Under Section 71 and Rule 18 of the Companies (Share Capital and Debentures) Rules, 2014, a company may also issue debentures redeemable on a contingency or on winding up, or perpetual debentures, if the issue is not otherwise invalid and the Rules are complied with.

What are the main features of a term loan?

A term loan has a fixed tenure, a repayment schedule, interest at an agreed rate, security and covenants. Banks or financial institutions sanction it after appraising the project. It is used mainly for fixed assets and expansion.

What is an ECB and how is it raised?

An external commercial borrowing is a loan raised by an eligible Indian entity from a recognised non-resident lender. It follows FEMA and RBI rules on borrower, lender, end-use, maturity and cost. Check the current RBI framework for the exact route.