Solution

The nature of the financial instrument issued by XYZ Limited is an optionally convertible debenture. This is because the instrument gives the issuer the option to either convert the debenture into a fixed number of its own shares at any time or redeem the instrument in cash at any time.

The debenture carries an interest rate of 7% per annum, and the holder has no conversion or redemption options. The debenture has a tenor of 12 years, and if not converted or redeemed earlier, will be repaid in cash at maturity, including accrued interest, if any.

The option to convert the debenture into equity shares of the issuer or redeem the instrument in cash at any time gives the issuer significant flexibility in managing its financial obligations. However, this flexibility comes at the cost of uncertainty for the holder, as the value of the instrument will depend on whether the issuer decides to convert the debenture into equity shares or redeem it in cash.

It is important to note that the specific classification of the instrument as either equity or financial liability will depend on the specific terms and conditions of the instrument, including the degree of variability in the conversion or redemption option.

In this case, since the holder has no conversion or redemption options, the instrument will likely be classified as a financial liability, as the issuer has an obligation to pay cash or equity shares upon conversion or redemption. The specific classification will depend on the specific terms and conditions of the instrument, including the degree of variability in the conversion or redemption option and the expected timing of the conversion or redemption.