When debentures are issued as collateral security, interest is paid on:

Question

Accepted Answer

The correct option is 4:
The issuance of debentures as collateral security is a specific financial arrangement where a company pledges its own debentures to a lender (like a bank) as an *additional* or *secondary* security for a primary loan. It is crucial for students to understand that the primary debt is the loan taken, and the company pays interest only on this loan amount, as per the loan agreement. The debentures are merely held as a contingent safeguard by the lender; they are not sold or issued to raise new funds from the market. Therefore, until the company defaults on the primary loan, the debentures remain dormant, and no separate, active interest is paid on them.

The incorrect option is 1:
Nominal value of debentures is the printed or face value, which is the figure typically used to calculate interest when debentures are actually issued to the public for cash. In the case of collateral security, the debentures are not issued for cash consideration; they are simply pledged against a loan. Paying interest on the nominal value would create an unjust double-interest burden on the company—it would be paying interest on the actual loan *and* on the pledged security—which is fundamentally unsound accounting and financial practice.

The incorrect option is 2:
Face value of debentures is interchangeable with nominal value in this context and represents the principal amount the company promises to repay to a debenture holder. As collateral debentures are not *active* debt instruments (they do not bring in cash as a primary source of finance), the interest provision associated with them does not come into effect. The face value only indicates the total amount of secondary security the lender can realise if the company defaults on the principal loan, but it is not the basis for an ongoing, regular interest payment.

The incorrect option is 3:
Discounted value of debentures refers to the issue price when a debenture is sold below its face value to the general public. This concept is completely irrelevant when debentures are issued as collateral security. Since the company is not selling the debentures for cash, there is no question of an issue price, a discount, or calculating interest on an imaginary discounted value. Interest on a regular issue of debentures, regardless of the issue price, is always calculated on the face/nominal value.