The cost of debenture refers to the interest rate or coupon rate that the issuer of the debenture agrees to pay to the debenture holders. It represents the cost of borrowing for the issuer.
When a company or government entity issues debentures, they are essentially borrowing money from investors. Debentures are typically long-term debt instruments that have a fixed interest rate and a specified maturity date. The issuer agrees to make regular interest payments to the debenture holders until the maturity date when the principal amount is repaid.
The cost of debenture is determined by various factors, including:
1. Market conditions: The prevailing interest rates in the market influence the cost of debenture. If interest rates are high, the cost of borrowing through debentures will also be high. Conversely, if interest rates are low, the cost of borrowing will be lower.
2. Creditworthiness of the issuer: The credit rating of the issuer plays a crucial role in determining the cost of debenture. If the issuer has a higher credit rating, indicating lower risk, they will be able to offer debentures at a lower interest rate. Conversely, issuers with lower credit ratings will have to offer higher interest rates to compensate investors for the higher risk.
3. Maturity period: The time period until the debenture matures affects the cost. Generally, longer-term debentures tend to have higher interest rates compared to shorter-term debentures.
4. Market demand and supply: The demand for and supply of debentures in the market can also impact their cost. If there is high demand for debentures, issuers may be able to offer them at a lower interest rate. Conversely, if the supply of debentures is high relative to demand, issuers may need to offer higher interest rates to attract investors.
It's important to note that the cost of debenture is distinct from the price at which debentures are bought and sold in the secondary market. The price of debentures in the secondary market can fluctuate based on market conditions, changes in interest rates, and other factors, which may cause the yield (effective interest rate) to differ from the coupon rate.
Overall, the cost of debenture reflects the interest rate that the issuer agrees to pay to debenture holders and is influenced by market conditions, creditworthiness, maturity period, and supply-demand dynamics in the market.
