Debentures vs. Bonds: An Overview

In a sense, all debentures are bonds, but not all bonds are debentures. Whenever a bond is unsecured, it can be referred to as a debenture.

To complicate matters, this is the American definition of a debenture. In British usage, a debenture is a bond that is secured by company assets. In some countries, the terms are interchangeable.

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Comparing Debentures And Bonds

Debentures

Debentures generally have a more specific purpose than other bonds. While both are used to raise capital, debentures typically are issued to raise capital to meet the expenses of an upcoming project or to pay for a planned expansion in business. These debt securities are a common form of long-term financing taken out by corporations.

Debentures carry either a floating or a fixed-interest coupon rate return to investors and will list a repayable date. When the interest payment is due, the company will, most often, pay the interest before they pay shareholder dividends.

On the due date, the company has two general choices of repayment of principal. They may pay in one lump sum or make installment payments. The installment plan is known as a debenture redemption reserve, and the company will pay a set amount each year to the investor until maturity. The terms of the debenture will be listed in the underlying documentation.

Debentures are sometimes called revenue bonds because the issuer expects to repay the loans from the proceeds of the business project they helped finance. Physical assets or collateral do not back debentures. They are backed solely by the full faith and credit of the issuer.

Some debentures, like other bonds, are convertible, meaning they can be converted into company stock, while others are non-convertible. Generally, investors prefer convertibles and will accept a slightly lower return to get them.

Like any bond, debentures can be purchased through a broker.

The convertible debenture can be converted into stock, and this feature will serve to dilute the per-share metrics of the stock and reduce any earnings per share (EPS). 

Bonds

The bond is the most common type of debt instrument used by private corporations and by governments. It serves as an IOU between the issuer and an investor. An investor loans a sum of money in return for the promise of repayment at the specified maturity date. Usually, the investor also receives periodic interest payments over the duration of the bond's term.

In the investing world, bonds are generally considered to be a relatively safe investment. Highly rated corporate or government bonds come with little perceived default risk. However, each bond, including those issued by government agencies or municipalities, will carry an individual credit rating.

In general, bonds are considered safe if unspectacular investments with a guaranteed rate of return. Generally, professional financial advisors encourage their clients to keep a percentage of their assets in bonds and to increase that percentage as they approach retirement age.

Special Considerations

The lack of security does not necessarily mean that a debenture is riskier than any other bond. Strictly speaking, a U.S. Treasury bond and a U.S. Treasury bill are both debentures. They are not secured by collateral, yet they are considered risk-free.

Similarly, debentures are the most common form of long-term debt instruments issued by corporations. A company might issue bonds to raise money to expand its number of retail stores. It expects to repay the money from future sales. The bond is considered as creditworthy as the company that issues it.

Bonds and debentures provide companies and governments with a way to finance beyond their normal cash flows.

Key Takeaways

  • A debenture is a form of unsecured debt (in American usage).
  • The debenture is the most common variety of bonds issued by corporations and government entities.
  • Strictly speaking, a U.S. Treasury bond and a U.S. Treasury bill are both debentures.