Life is full of surprises, and even more so when it comes to finances. A person having a good income today may face financial crisis in future. To avoid these unforeseen financial crises everyone invests in different instruments that can fetch extra income. There are many options available in the market that can be classified as risky and non risky. It is very well understood that risky options yield higher gains but non risky ones can give very low returns. Debentures and bonds are two such options that can be taken for good returns on ones investment. Debenture is an instrument issued by a company that can be convertible or non convertible into equities. Bonds are issued by companies or by government and can be seen as a loan taken by them to meet their financial needs. These two instruments are basically loan taken from the investor but have very different repayment conditions.
Debentures
Debentures are issued by a company to raise short to medium term loan needed for expenses or for expansions. Just like equities these can be transferred to anyone, but does not give right of voting in the company’s general meetings. Debentures are simply loans taken by the companies and do not provide the ownership in the company. These are unsecured loans as company is not bound to return the principal amount on the maturity. Debentures are of two types convertible and nonconvertible. The convertible debentures are the ones that can be converted into equity shares at a later time. This convertibility provides attraction to the investor but yield lower interest rates. Non convertible debentures does not convert into equity shares thus can yield a higher interest rate.
Bonds
Bonds are actual contract notes issued by the borrower to pay interest at regular intervals and return the principal on the maturity of the bond. These bonds are issued by the companies for their expenses and future expansions. The bonds are also issued by the government for its expenses. A bond is seen as loan taken by a borrower from the investor so unlike equity share it does not give stake in the company but he is seen as a lender. These bonds are redeemed at a definite time. These are secured loans and can yield low to medium interest rate.
Difference between bonds and debentures
Both bonds and debentures are instruments available to a company to raise money from the public. This is the similarity between the two, but on closer inspection, we find that there are many glaring differences between the two.
Bonds are more secure than debentures. As a debenture holder, you provide unsecured loan to the company. It carries a higher rate of interest as the company does not give any collateral to you for your money. For this reason bond holders receive a lower rate of interest but are more secure.
If there is any bankruptcy, bondholders are paid first and the liability towards debenture holders is less.
Debenture holders get periodical interest on their money and upon completion of the term they get their principal amount back.
Bond holders do not receive periodical payments. Rather, they get principal plus interest accrued upon the completion of the term. They are much more secure than debentures and are issued mostly by government firms.
| In Brief:
• Bonds are more secure than debentures, but the rate of interest is lower • Debentures are unsecured loans but carries a higher rate of interest • In bankruptcy, bondholders are paid first, but liability towards debenture holders is less • Debenture holders get periodical interest • Bond holders receive accrued payment upon completion of the term • Bonds are more secure as they are mostly issued by government firms |