Difference between Bonds and Debentures

Bonds

Bonds are debt financial instruments that both public and private sector companies use to raise funds for their operations. The government agencies, financial institutions as well as private enterprises issue these instruments to investors. Bonds are secured by their physical assets. The holder of these bonds is the lender, while the issuer of these bonds is the borrower. The borrower can issue these bonds to the lender, only by promising to pay back the loan at a specific maturity date with a fixed interest rate. This interest rate is generally lower than debentures because the physical assets of a company secure bonds whereas the debentures are unsecured instruments.

Debentures

Debentures are also debt financial instruments like bonds. Organisations use these instruments to get funding for their daily needs. They are generally not secured by any physical assets of the issuers, which makes them riskier than bonds. They also carry a fixed or floating interest rate. The debenture holders get first preference over shareholders of a company when it comes to the payment of interests/dividends. The interest rate on debentures is generally higher than bonds because they are not secured by the physical assets of a company.

Differences between Bonds and Debentures

The main differences between Bonds and Debentures are as follows:

Bonds

Debentures

Definition

Bonds are debt financial instruments issued by large corporations, financial institutions and government agencies that are backed up by collaterals or physical assets.

Debentures are debt financial instruments issued by private companies, but any collaterals or physical assets do not back them up.

Owner

The owner of a bond is called a bondholder.

The owner of a debenture is called a debenture holder.

Collateral

Bonds get secured by the collateral or physical assets of the issuing company.

Debentures do not get secured by the collateral or physical assets of the issuing company. Lenders purchase these instruments solely based on the reputation of the issuing company.

Tenure

Bonds are long term investments and their tenure is generally higher than debentures.

Debentures are generally short to medium term investments and their tenure is usually lower than bonds.

Issuer

Large corporations, financial institutions and government agencies issue these bonds for their long term capital requirements.

Private companies generally issue debentures for their immediate capital requirements.

Rate of Interest

The bonds carry a fixed or floating interest rate that is generally lower than debentures because they are more stable in terms of repayment, and they get backed by collateral of the issuing company.

The debentures carry a fixed or floating interest rate that is generally higher than bonds because they are less stable in terms of repayment, and they are also not backed by collateral.

Priority During Liquidation

If the company is on the verge of liquidation, the bondholders are given priority over debenture holders for repayment of capital and interest amount.

If the company is on the verge of liquidation, the debenture holders are given second priority over bondholders for repayment of capital and interest amount.

Payment Structure

The payment of interest for bonds is on an accrual basis. The issuing company pays this amount on a monthly, half-yearly or yearly basis and this payment is not dependent on the performance of a company.

The payment of interest for bonds is done on a periodical basis and depends on the company’s performance.

Risk

Bonds are less riskier than debentures because they have the security of the physical assets of the issuing company.

Debentures are riskier than bonds because they do not have the security of the physical assets of the issuing company.

Conclusion

There are a number of differences between bonds and debentures. However, both are important when it comes to raising capital to finance the short and long term needs of a corporation. Lenders who prefer low-risk investments when compared to shares put their money in financial instruments like bonds and debentures.

Frequently Asked Questions

What are convertible debentures?

Convertible debentures are long term financial instruments that a company can transform into equity shares after a fixed period of time. They are usually unsecured bonds with no collateral to back up their debt. They are hybrid financial products that have features both of equity as well as debt.

What are convertible bonds?

Convertible bonds are fixed income long term financial instruments that a company can transform into equity shares after a specified period of time. The bonds get secured with the company’s physical assets, and the bonds get converted only at the discretion of the bondholder. They are also hybrid financial products that have features both of equity as well as debt.

Why are bonds and debentures called debt instruments?

Bonds and Debentures are known as debt instruments because companies use them to raise capital with a promise to repay it after a fixed period of time. The companies also pay a fixed or floating interest rate on this capital on specified periods during the tenure of this debt instrument.

What are the different types of debentures?

There are eight main types of debentures issued by a company, which are as follows:

  • Secured debentures
  • Convertible debentures
  • Registered debentures
  • Redeemable debentures
  • Unsecured debentures
  • Non-redeemable debentures
  • Non-convertible debentures
  • Bearer debentures

What are the different types of bonds?

There are ten main types of bonds issued by government agencies, financial institutions and corporations which are as follows:

  • Fixed-rate bonds
  • War bonds
  • Perpetual bonds
  • Inflation-linked bonds
  • Floating rate bonds
  • Bearer bonds
  • Climate bonds
  • Serial bonds
  • Subordinated bonds
  • Zero-interest rate bonds

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