Bonds vs Debentures
We often use the terms bonds and debentures interchangeably. While they are similar products there is a subtle difference between bonds and debentures. To begin with, both are debt instruments and both pay fixed returns committed through the term. While bonds pay the bond rate of interest, debentures pay the debenture rate of interest, which could be higher since debentures are predominantly issued by the private sector and are unsecured.
Bonds are available as convertible bonds and non-convertible bonds, although the latter are a lot more common. Here we look at the different types of bonds and debentures available in the debt market and also at some of the very key areas of differences between the two. Some are even called debenture bonds since it is ultimately a commitment to pay a fixed sum plus principal at the end of the term. But now let us look at the concept and then move on to the differences.
What is a bond and what is a debenture?
Let us look at bonds first and foremost. A bond is a debt instrument that is issued and offered by government agencies, banks and financial corporations as well as occasionally by private companies too. The idea of issuing bonds is to raise additional resources for the business. The investors are the creditors or the bondholders. The issuers are the borrowers who borrow money through bonds. Like the word bond suggests, it is a commitment against the funds raised. There is a detailed fundraising document which acts as a promise or IOU between bond lenders and borrowers. Bonds are normally secured loans (secured by a charge on the assets of the company or future cash flows) taken from the public in return for offering a specified rate of interest and repayment of the bond principal amount upon the date of maturity specified on the bond.
Let us now turn to what are debentures. While debentures are also debt instruments (similar to bonds), they are issued by private companies for a special purpose that is mentioned in advance. Unlike bonds, which are for a very generic purpose, debentures are for a very specific purpose and this can include reasons like expanding the manufacturing capacity, buying new machinery, expanding the factory premises, starting a new project, diversifying into new businesses, funding acquisitions and mergers etc.
Table of Content
What are Bonds?
Bonds are debt instruments that are issued by governments or businesses to raise money from investors for a set period of time. These fixed-income securities enable bondholders to receive periodic interest payments in the form of coupons. As a result, bond issuers are lenders or investors, and bondholders are lenders or investors.
Example: You paid Rs 1,000 for a bond with a 2-year maturity and a set coupon rate of 5%.
You will receive a Rs 50 coupon or bond yield in a year. When your bond matures in two years, you will get Rs. 1,050 back, which includes:
The par value of Rs.1000
Your Rs. 50 coupon/bond yield (determined using a coupon rate of 5% interest)
Therefore, your bond's final coupon/bond yield will be Rs 100.
What are Debentures?
Bonds or other types of debt that do not need repayment are known as debentures. Debentures are debt instruments that lack security and rely instead on the creditworthiness and reputation of the person or business who issued them. Debentures are typically issued by businesses and governments to raise funds.
Example: Let's say a business issued debentures for Rs. 4,20,000 with a 4% coupon rate (interest rate). The following is the calculation for interest payments:
Interest Payment is equal to Interest Rate/100 * Debt Amount, or 4/100*4,20,000, which is Rs. 16,800.
Key differences between bonds and debentures
Having understood the concept underlying bonds and debentures, let us look at some of the areas of differences between bonds and debentures. At times the difference between bonds and debentures is very clear and at times it is very subtle. Here are some of the key differences between bonds and debentures.
1) A bond is a debt instrument issued predominantly by private or public sector companies or even special organizations, or special purpose vehicles. The purpose of the bond is to raise funds from the general public with a commitment.
Key differences between bonds and debentures
Bonds are debt financial securities with a physical asset and collateral backing that are issued by financial institutions, large enterprises, and governmental organisations.
Debentures are financial instruments that are used to fund private company debt that is not backed by any assets or collateral.
There is a longer term.
The time period will be quite brief.
An owner of bonds is known as a bondholder.
A holder of a debenture is referred to as its owner.
Bonds are often backed by the issuing company's actual assets or collateral.
Debentures lack any form of collateral backing and are therefore unsecured. The trustworthiness and reputation of the issuer are crucial supporting elements.
Due to the presence of collateral, the risk is decreased.
Due to the lack of collateral, the risk level is noticeably greater.
Debentures and bonds are both forms of debt that governments and corporations employ to raise money. Even though they are similar, they also have unique qualities that make them stand out. Your option selection should be based on your investing objectives, level of risk tolerance, and time horizon. Establish the investment goal, evaluate the risk profile, thoroughly investigate the market, and select an appropriate investment route. Beginners who wish to start trading stocks may find it beneficial to utilise an intuitive trading platform like blinkX. You can trade from your smartphone using blinkX trading app an avoid missing any investment opportunities.
Frequently Asked Questions
When a business needs to borrow money, it will issue debentures, which are medium- or long-term debt instruments. Private and public firms issue bonds as a kind of debt to raise money.
They are referred to as debt instruments because they are used by businesses to obtain cash with the commitment to repay it after a set amount of time. Additionally, businesses give interest to their investors.
Being unbacked by any form of collateral makes debentures unsafe. Only the reputation and rating of the issuing corporation and credit rating agencies are important. Since bonds are backed by collateral, they are more secure than debentures.
Choose Smart Investments Today.
Open Free Demat Account*