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Difference Between Debentures and Bonds

Writer # Indiabonds | November 30, 2022

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A loan is the most common method of obtaining the necessary funds. There are numerous ways to borrow money, but the two most common are bonds and debentures. These financial debt instruments have different functions and are issued to attract investment or money from you, i.e., the general public. All debentures are bonds, but not all bonds are debentures.

Let’s learn how bonds and debentures differ.

What is Debenture?

The most popular type of bond issued by private companies is debentures. Debentures are issued to raise money to pay for a forthcoming project’s expenses or business development. These debt securities are a popular type of long-term debt that businesses borrow.

Debentures can be either secured or unsecured. When a debenture is secured, it is supported by collateral. To put it simply, you get some insurance against a loan. An unsecured debenture carries a higher risk than a bond because there is no tangible asset backing it, and you must rely on the credit ratings of the company issuing it for security. For example, the difference between a personal loan and a home loan where a personal loan does not require collateral but a home loan does. The interest rate on debentures may be fixed or variable. They give you a return on investment in the form of a variable or fixed coupon rate of interest. In the distribution of interest and dividend payments, being a debenture holder gives you priority over the shareholders of the corporation. Since debentures are not always backed by a company’s tangible assets, their interest rates are typically higher than those of bonds.

What are Bonds?

The most popular type of debt instrument is a bond which is a secured investment. Corporations, financial institutions, and government businesses distribute these instruments to you.

By holding bonds, you become the lender, and the issuer of the bonds becomes the borrower. Bonds serve as a form of promissory note between you and the borrower. You lend a sum of money with the promise that it will be reimbursed on or before the maturity date of the note. Most of the time, you will also qualify to receive ongoing interest payments for the bond’s term.

Bonds are frequently regarded as a relatively risk-free investment choice. As a company’s tangible assets serve as collateral for its bonds, the interest rate is typically lower than that of debentures.

Key Differences between Bonds and Debentures

Key PointsDebenturesBonds
DescriptionDebentures help raise money for the long or short term. It can be either secured or unsecured.A bond is a type of financial instrument that corporations, financial institutions, and governmental organizations can use to raise money from you. They promise to pay you interest on the loan at the bond’s maturity date. Collateral or tangible assets serve as the security for bonds.
Lender/IssuerDebentures are typically issued by private companies to meet their short-term capital needs.For their long-term capital requirements, corporations, financial institutions, and governmental organizations issue bonds.
Holding EntityYou become a “debenture holder” when you receive debentures.You become a “bond holder” when you receive bonds.
EstimationsDebentures = Assets – (Liabilities + Shareholder’s reserve + Bonds)Bonds = Assets – (Liabilities + Shareholder’s reserve + Debentures)
CollateralWhen a debenture is secured, it is supported by collateral. Debentures are not always collateralized or physically secured by the issuing company’s assets. You must rely on the issuing company’s credit ratings as security.Collateral or tangible assets of the issuing corporation serve as security for bonds.
Interest rateDebentures offer high-interest rates because they are less reliable in terms of repayment. They have a fixed or fluctuating interest rate.Bonds have an interest rate, often known as a coupon that must be paid at regular intervals until the bond reaches maturity. Their interest rates are low due to future repayment stability and collateral support.
DurationDebenture investments are made with a specific goal in mind. Depending on the goal the organization pursues, its tenure may be short or long. Debentures often have shorter terms than bonds.Bonds are long-term investments. Their issuer determines the term. The tenure of bonds is often longer than that of debentures.
Structure of PaymentThe prospectus states that interest on debentures is paid periodically. This interest is determined by how well the issuing corporation performs.Bond interest is paid monthly, semi-annually, or annually on an accrual basis. These payments are not impacted by the company’s performance.
ConvertibilityDebentures may have a feature of convertible debentures where you can convert the debenture into stocks at a specific time.Bond does not have any such feature

Where Should You Invest: In Debentures or Bonds?

If you are an investor with high-risk tolerance levels, you might consider investing in debentures. In unsecured debentures, due to the lack of any assets backing them, you must choose the company based on its trustworthiness and reputation for investment. When it comes to convertible debentures, they have a benefit. Here, you can exchange them for equity shares of the business. Debentures provide you with greater returns than bonds do.

Bond investments are ideal for you if you are an investor with a low-risk tolerance. Due to the guarantee of a principal and fixed interest payment after a certain amount of time, they are less risky. Bonds can provide you with a reliable source of income. They may be less risky, but you should still be aware of the inflation risk because it could lower the value of your assets.

Conclusion

It’s common to compare bonds with debentures. Bonds and debentures are two distinct debt products, albeit they may have certain similarities. Being constantly equipped with essential and accurate knowledge is the first step in avoiding investing hazards.

When selecting a financial instrument, you should base your decision on the returns you expect from investments. Equity are excellent for your long-term goals. Conversely, debt are appropriate for your short-term investments and are low-risk. Investing in debt and equity funds will help you diversify risk as a result making your short-term and long-term goals easily achievable.