Bond vs. Debenture

How a bond differs from a debenture

Finances are tricky. One day you can be financially secure and the next day your finances can be in a mess. There are ways of planning for the future so you can avoid unexpected financial crises if you look at the different instruments associated with investing. You may have the idea that investments are risky, but there are those available that are classified as being non-risk. At the same time the returns from risky ventures can be high while those from non-risky ventures are usually lower.

Two options you can consider as investments are bonds and debentures because they do produce good returns. A debenture is issued by a company and can be converted into equity or it may be non-convertible. Bonds are taken by the government or companies as a type of loan to help them with their finances. Even though both a bond and a debenture is a loan from the investor, there are great differences in the repayment conditions.

What are debentures?

Companies issue debentures when they need to raise money for a short or medium term. They may need the money to cover expenses or to help pay for expansions they wish to make. You can transfer a debenture to anyone, but having one does not make you a shareholder and you do not have the right to vote at general meetings held by the company. As an investor in this way you are simply a lender from whom the company is borrowing money.

A debenture is an unsecured loan and the company is not under any obligation to repay the amount borrowed when the debenture comes due. There are convertible and non-convertible debentures. A convertible debenture can be converted to equity at a later date and this is why it is more attractive to investors. However, it does not pay a high rate of interest. You cannot covert the non-convertible debentures into equity, but they do have higher rates of interest.

What are bonds?

Bonds are contracts in which the government or company agrees to borrow a set amount of money for a certain period of time. They are still used to help the issuer raise money, but that is the only similarity between bonds and debentures.

If you are looking for a secure investment, then bonds are the best option. But, bonds pay a lower rate of interest. If the company goes bankrupt, those who hold bonds are the first ones to receive their money. Debenture holders do not have this security.

Those who hold debentures receive periodic payments for the interest on the money they have invested and at the end of the term they receive payment of the principal. Bond holders do not receive any periodic payments. At the end of the term they receive a lump sum consisting of the principal and the interest that has accrued.

Summary

  1. Bonds have a lower rate of interest, but they are more secure.
  2. Debentures have a higher rate of interest because they are basically unsecured loans.
  3. Bondholders are paid first in a bankruptcy, but debenture holders do not have this security.
  4. Bondholders do not receive periodic payments and receive the principal plus interest at the end of the term.
  5. Bonds are usually issued by the government.