Debentures vs. Fixed Deposits: An Overview
Debentures and fixed deposits are two different ways of investing money through relatively low-risk financial instruments. A debenture is an unsecured bond. Essentially, it is a bond that is not backed by a physical asset or collateral.
A fixed deposit is an arrangement with a bank where a depositor places money into the bank and receives a regular, fixed-interest profit.
- Fixed deposits are a type of product offered by a bank with a fixed interest payout.
- Debentures are unsecured debt instruments issued by businesses to raise capital funding, and with more complex structuring provisions than fixed deposits.
- The debenture may include fixed or floating interest, and they may be either convertible or nonconvertible.
What Is a Debenture?
A debenture is a type of bond. However, the term debenture only applies to an unsecured bond. Therefore, all debentures can be bonds, but not all bonds are debentures. In business or corporate financing, unsecured debentures are typically riskier requiring the payment of higher coupons. Companies often favor issuing secured bonds because they can pay a lower coupon rate.
An unsecured corporate bond issued from Apple would be an example of a debenture. A corporate mortgage bond issued to a select group of creditors that includes a collateralized provision for the property would be an example of a secured bond not considered a debenture.
Sometimes, debentures are issued with provisions that allow the holder to exchange the debenture for company stock. Nonconvertible debentures are unsecured bonds that cannot be converted to company equity or stock. Nonconvertible debentures usually have higher interest rates than convertible debentures.
All debentures have specific features. First, a trust indenture is drafted, which is an agreement between the issuing corporation and the trust that manages the interest of the investors. Next, the coupon rate is decided, which is the rate of interest that the company will pay the debenture holder or investor. This rate can be either fixed or floating depending on the company's credit rating or the bond's credit rating.
Debentures are issued through brokers and syndicates. Fixed deposits are a type of product offered through a bank.
For nonconvertible debentures, the date of maturity is also an important feature. This date dictates when the issuing company must pay back the debenture holders. The most common form of repayment is called a redemption out of capital. Through this redemption, the issuing company makes a lump sum payment on the date of maturity.
A substantial portion of the bonds traded on standard bond platforms is debentures. Thus, debentures can be easier to invest in than secured bonds. Many secured bonds are issued to a select group of investing creditors. Some secured bonds may also be bought through brokerage platforms, but many require a full-service broker.
What Is a Fixed Deposit?
A fixed deposit, also known as a time deposit, is a type of product offered through banks. When a depositor places money in a fixed deposit, the amount of profit or interest paid on the investment is fixed. The rate will not increase or decrease at any time regardless of fluctuations in interest rates. The interest rate offered by fixed deposits is usually set by prevailing low-risk market standards like the London Inter-bank Offered Rate (LIBOR) or Treasury rate.
Fixed deposits can have maturities from one week to five years. Fixed deposits cannot be redeemed early. In other words, money cannot be withdrawn for any reason until the time-duration on the deposit has expired. If money is withdrawn early, then the bank can charge an early withdrawal penalty or fee.
A very common example of a fixed deposit account is a certificate of deposit (CD).
Both individual investors and businesses may choose to invest in fixed deposit products. For retail investors, fixed deposit CDs are offered by many different banking institutions. For companies, the negotiation and investment account procedures will typically vary and usually include special provisions specific to the business’ needs.
Debentures and fixed deposits have several key differences. Debentures can only be issued by businesses and are used to raise capital. An investor investing in a debenture is investing in a company and should understand that company’s specific risks.
Investing in a fixed deposit can be done by both individuals and institutions. Investing in a fixed deposit involves understanding the provisions of the product but does not typically involve a high risk associated with the activities of the offering bank as the Federal Deposit Insurance Corporation (FDIC) insures most fixed deposits.