What Is A Debenture Bond?

It is a debt security, issued by a government or large company, that is not secured by an asset or lien, but rather by the all issuer's assets not otherwise secured. That is, a debenture carries no collateral and is considered unsecured; in case of bankruptcy, the debenture holder is considered a general creditor. A debenture can be traded, and the term is often interchangeable with a bond. Debentures issued by governments are considered risk-free.

There are two types of debentures:

    1. Convertible debentures, which are convertible bonds or bonds that can be converted into equity shares of the issuing company after a predetermined period of time. "Convertibility" is a feature that corporations may add to the bonds they issue to make them more attractive to buyers. In other words, it is a special feature that a corporate bond may carry. As a result of the advantage a buyer gets from the ability to convert; convertible bonds typically have lower interest rates than non-convertible corporate bonds.

    2. Non-convertible debentures, which are simply regular debentures cannot be converted into equity shares of the liable company. They are debentures without the convertibility feature attached to them. As a result, they usually carry higher interest rates than their convertible counterparts.

Companies issue debenture bonds to raise money, often for capital improvements or other projects. Debenture bonds are usually used to fund projects that are expected to be revenue-producing in the future. A company will usually issue these bonds if it does not want to issue additional stock, which would dilute the price of existing shares.

Investors purchase debenture bonds because they have a fixed rate of return. The return is the interest paid on the bond, which can be paid over time or in a lump sum at the end of the bond's term. Debenture bonds can be less risky than stocks, particularly if they are issued by government agencies.

Debenture bonds may be issued at a discount — less than face value — and pay face value at maturity, or they be purchased at face value and pay interest at regular periods. When a bond is issued at a discount, the difference between the purchase price and the face value represents the interest, or return, on the bond. If a bond is purchased at face value, the interest, which is usually paid every six months, represents the investor's return.

Bondholders are considered general creditors. Since debenture bonds are unsecured, investments may be at risk if the company goes bankrupt and cannot pay the interest or maturity value of the bonds. In this case, bondholders get paid only after secured creditors are paid, although they will usually be paid before common stockholders.

Subordinated debenture bonds are those bonds that are paid after other, non-subordinated, obligations. Government-issued bonds are generally considered risk-free because the government can raise taxes or print more money in order to meet its obligations.