Loading the player...

What is a 'Debenture'

A debenture is a type of debt instrument that is not secured by physical assets or collateral. Debentures are backed only by the general creditworthiness and reputation of the issuer. Both corporations and governments frequently issue this type of bond to secure capital. Like other types of bonds, debentures are documented in an indenture.

BREAKING DOWN 'Debenture'

Debentures have no collateral. Bond buyers generally purchase debentures based on the belief that the bond issuer is unlikely to default on the repayment. An example of a government debenture would be any government-issued Treasury bond (T-bond) or Treasury bill (T-bill). T-bonds and T-bills are generally considered risk free because governments, at worst, can print off more money or raise taxes to pay these types of debts.

Debentures are the most common form of long-term loans that can be taken out by a corporation. These loans are repayable on a fixed date and pay a fixed rate of interest. A company normally makes these interest payments prior to paying out dividends to its shareholders, similar to most debt instruments. In relation to other types of loans and debt instruments, debentures are advantageous in that they carry a lower interest rate and have a repayment date that is far in the future.

Convertible and Non-Convertible Debentures

There are two types of debentures as of 2016: convertible and non-convertible. Convertible debentures are bonds that can convert into equity shares of the issuing corporation after a specific period of time. These types of bonds are the most attractive to investors because of the ability to convert, and they are most attractive to companies because of the low interest rate.

Non-convertible debentures are regular debentures that cannot be converted into equity of the issuing corporation. To compensate, investors are rewarded with a higher interest rate when compared to convertible debentures.

Features of a Debenture

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 and depends on the company's credit rating or the bond's credit rating.

For non-convertible debentures, the date of maturity is also an important feature. This date dictates when the issuing company must pay back the debenture holders. However, the company has a few options for how it will repay. The most common form of repayment is called a redemption out of capital, in which the issuing company makes a lump sum payment on the date of maturity. A second option is called a debenture redemption reserve, in which the issuing company transfers a specific amount of funds each year until the debenture is repaid on the date of maturity.

RELATED TERMS
  1. Fixed Debenture

    A fixed debenture is a debt that mortgages some of the borrower's ...
  2. Convertible Hedge

    A convertible hedge is a strategy where an investor purchases ...
  3. Small Business Investment Company ...

    Though privately-owned, a small business investment company is ...
  4. Premium Adjustable Convertible ...

    A debt instrument that combines a coupon paying bond with the ...
  5. Non-Fluctuating

    The characteristic of constancy in a security or measurement's ...
  6. Convertible Arbitrage

    Convertible arbitrage is a trading strategy that involves taking ...
Related Articles
  1. Investing

    An Introduction to Convertible Bonds

    Getting caught up in all the details and intricacies of convertible bonds can make them appear more complex than they really are.
  2. Investing

    Convertible bonds: pros and cons for companies and investors

    Understand what effect convertible bonds have on investors and companies. Find out the advantages, disadvantages, and what the issue means from a corporate standpoint before buying in.
  3. Investing

    The Top 6 Convertible Bond Funds for 2016

    Take a look at convertible bond mutual funds that are well-positioned heading into 2016, and why investors might consider a convertible fund portfolio.
  4. Insights

    BlackBerry to Sell $605 Million of Convertible Debt to Fairfax (BBRY, FRFHF)

    Amid a shrinking hold on a weak smartphone market, BlackBerry continues to build out its money-losing handset business while shifting focus to software.
  5. Investing

    3 Best High-Yielding Convertible Bond ETFs (CWB, ICVT)

    Discover how convertible bond ETFs can offer investors growth and income while hedging fixed income portfolios in a rising rate environment.
  6. Investing

    CWB: SPDR Barclays Convertible Secs ETF

    Read an in-depth analysis of the SPDR Barclays Capital Convertible Bond ETF, which tracks an index of high-growth potential convertible bonds.
  7. Investing

    Corporate Bonds: Advantages and Disadvantages

    Corporate bonds can provide compelling returns, even in low-yield environments. But they are not without risk.
  8. Investing

    How To Evaluate Bond Performance

    Learn about how investors should evaluate bond performance. See how the maturity of a bond can impact its exposure to interest rate risk.
  9. Investing

    Why Bond Prices Fall When Interest Rates Rise

    Never invest in something you don’t understand. Bonds are no exception.
RELATED FAQS
  1. Preference shares vs. debentures

    Learn why preference shares are equity securities and debentures are debt securities. Understand the differences between ... Read Answer >>
  2. Nonconvertible debentures versus fixed deposits

    Nonconvertible debentures and fixed deposits are two different ways of investing money. Learn about the differences in how ... Read Answer >>
  3. Why do companies issue 100-year bonds?

    Although it is rare, companies do issue bonds that exceed an average person's life expectancy. For example, multi-billion ... Read Answer >>
  4. What is the difference between convertible and reverse convertible bonds?

    The difference between a regular convertible bond and a reverse convertible bond is the options attached to the bond. While ... Read Answer >>
  5. Why would a corporation issue convertible bonds?

    Discover how corporations issue convertible bonds to take advantage of much lower interest rates as a result of a conversion ... Read Answer >>
Hot Definitions
  1. Leverage

    Leverage results from using borrowed capital as a source of funding when investing to expand the firm's asset base and generate ...
  2. Financial Risk

    Financial risk is the possibility that shareholders will lose money when investing in a company if its cash flow fails to ...
  3. Enterprise Value (EV)

    Enterprise Value (EV) is a measure of a company's total value, often used as a more comprehensive alternative to equity market ...
  4. Relative Strength Index - RSI

    Relative Strength Indicator (RSI) is a technical momentum indicator that compares the magnitude of recent gains to recent ...
  5. Dividend

    A dividend is a distribution of a portion of a company's earnings, decided by the board of directors, to a class of its shareholders.
  6. Inventory Turnover

    Inventory turnover is a ratio showing how many times a company has sold and replaces inventory over a period.
Trading Center