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Debenture Explained

Debenture Explained

what is a debenture

In Canada, a debenture refers to a secured loan instrument where security is generally over the debtor’s credit, but security is not pledged to specific assets. As stated earlier, debentures are only as secure as the underlying issuer’s financial strength. If the company struggles financially due to internal or macroeconomic factors, investors are at risk of default on the debenture. As some consolation, a debenture holder would be repaid before common stock shareholders in the event of bankruptcy. Regular debt instruments that are not convertible into equity shares.

The bond is considered as creditworthy as the company that issues it. The bond is the most common type of debt instrument used by private corporations and by governments. An investor loans a sum of money in return for the promise of repayment at the specified maturity date. Usually, the investor also receives periodic interest payments over the duration of the bond’s term. Convertible debentures are bonds that can convert into equity shares of the issuing corporation after a specific period.

Meaning of debenture in English

There are various agencies that assess credit ratings in order to gauge the quality of a bond in terms of credit performance. The main advantage of debentures to companies is the fact that they have a lower interest rate than e.g. overdrafts. Also, they are usually repayable at a date far off in the future. To complicate matters, this is the American definition of a debenture. In British usage, a debenture is a bond that is secured by company assets. The three main features of a debenture are the interest rate, the credit rating, and the maturity date.

what is a debenture

To understand what a debenture is, it’s helpful to review the various ways that companies can borrow money. A “secured” debt is a type of bond that is backed by something. A mortgage bond, for example, is backed by land or a building. Companies might also float equipment bonds that are backed by the machinery it owns. Most debentures are secured on the borrower’s reputation or credit history (in the US), and based on the borrower’s assets in the UK. However, some debentures are not (these can be known as ‘naked’ or ‘unsecured’ debentures).

What are the features of a debenture?

Considered low-risk investments, these government bonds have the backing of the government issuer. Credit ratings are provided by independent credit rating agencies in the country and denote the creditworthiness of the underlying issuer. For instance, a lower credit rating bond would most likely provide higher interest than a higher-rated bond. NCDs are prone to risks concerning business management and funding. Thus, the credit rating can be severely impacted if the turnover is negatively influenced. The company must acquire extra funds from non-banking financial corporations or banks to compensate for the impact.



Posted: Thu, 22 Jun 2023 10:00:00 GMT [source]

This is in contrast to loans that are typically based on collateral. Debentures also have the potential to provide more flexibility than stocks. There’s no option cost of debt for converting your equity in a company into a debenture. But if you invest in a convertible debenture, you could someday convert that into company shares.

What are the advantages and disadvantages of a debenture?

It is required that this interest is paid prior to dividends being paid to shareholders. This information is educational, and is not an offer to sell or a solicitation of an offer to buy any security. This information is not a recommendation to buy, hold, or sell an investment or financial product, or take any action. This information is neither individualized nor a research report, and must not serve as the basis for any investment decision. All investments involve risk, including the possible loss of capital. Past performance does not guarantee future results or returns.

Generally, debentures are issued with a fixed rate of interest, which is called the Coupon Rate. A debenture holder receives interest according to the coupon rate specified in the debenture certificate. For the lender, debentures are generally a good thing, as it removes any risk of repayment and replaces it with returns guaranteed by U.S. Treasury bonds (or, in some cases, bonds issued by Fannie Mae, Freddie Mac, or Ginnie Mae). The interest and principal on such instruments can be provided monthly, annually, or quarterly based on the fixed tenure mentioned. Thus, there is some risk in purchasing debentures, especially when compared to secured debt, which is why debentures are much more common among companies with high credit ratings.

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Nonconvertible debenture

In contrast, non-convertible debentures will remain a fixed-income instrument throughout history. The platform provides unparalleled efficiencies, including digitisation, access to repositories, and actionable insights for all counter-parties in the sale within minutes. Yubi Invest also provides efficient credit and price discovery, and liquidity in the secondary market for non-AAA-rated papers. It’s common for companies to float bonds to help fund operations and invest in growth.

  • This can be beneficial for borrowers who want to have a predictable monthly payment.
  • Debentures are often issued when a corporation or government needs to raise capital for a specific purpose.
  • Most often, it is as redemption from the capital, where the issuer pays a lump sum amount on the maturity of the debt.
  • You’re stuck with the opportunity cost of not making as much money as you potentially could have.
  • Alternatively, the payment may use a redemption reserve, where the company pays specific amounts each year until full repayment at the date of maturity.

Sorting through all the debt securities options that are out there can be confusing; a financial advisor can help you find which ones work best for your financial plan. A debenture is an unsecured debt issued by a company or government to raise capital. Because there is no collateral backing the debt, the debentures can be riskier than secured debt.

What are the types of debentures?

Overall, debentures, as with other bonds, tend to be lower-risk investments. Even though they are unsecured, investors can usually be confident that they’ll get their money back. US Treasury bonds, for example, are debentures that are considered virtually risk-free, as the US government backs them. A secured bond is backed by collateral, such as a property or equipment. An unsecured bond, like a debenture, doesn’t have any collateral backing it up. Investors rely only on the trustworthiness and credit rating of the company or government issuing the bond.

What is the difference between a bond and a debenture?

Bonds are debt financial instruments issued by financial institutions, big corporations, and government agencies having the backing of collaterals and physical assets. Debentures are debt financial instruments issued by private companies but are not backed by any collaterals or physical assets.

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