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Debentures and bonds are types of debt instruments that can be issued by a company. In some markets (India, for instance) the two terms are interchangeable, but in the U.S., they refer to two separate kinds of debt securities.

The functional differences center around the use of collateral, and they are generally purchased under different circumstances.

Understanding Bonds

Bonds are the most frequently referenced type of debt instrument, serving as an IOU between the issuer and the purchaser. An investor loans money to an institution, such as a government or business; the bond acts as a written promise to repay the loan on a specific maturity date.

Normally, bonds also include periodic interest payments over the bond's duration, which means that the repayment of principal and interest occur separately. Bond purchases are generally considered safe, and highly rated corporate or government bonds come with little perceived default risk.

Differentiating Debentures

Debentures have a more specific purpose than bonds. While both can be used to raise capital, debentures are typically issued to raise short-term capital for upcoming expenses or to pay for expansions. Sometimes called revenue bonds (because they may be expected to be paid for out of the proceeds of a new business project), debentures are never asset-backed, which means that they are not secured by any collateral

Debentures are backed solely by the full faith and credit of the issuer. Like bonds, debentures can be purchased through a broker.

Financing Beyond Normal Cash Flows

Bonds and debentures provide companies and governments with a way to finance beyond their normal cash flows. Some debentures and bonds are convertible, which means that they can be converted into company stock.

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.

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