An Explanation About Type of Securities: Debentures / Bonds

Debenture comes from the Latin word ‘debere’ which translates to ‘borrow’. Issuing debentures is a way for companies to finance their work. The terms Debentures/bonds are used interchangeably, but there is a considerable difference between the two. Debentures are a class of bonds, but bonds cannot come under the category of debentures. Generally, Private Companies or governments issue bonds to finance a particular project or meet their business expansion expenses and Public companies issues debentures. Both are suitable for long-term financing. They can be issued at either a fixed or a floating interest rate. There is a repayable rate associated with debentures. The bonds, including those issued by government agencies or municipalities, shall have respective credit ratings upon which the investor can asses the risk associated with the bonds. There are various types of debentures that would be covered in this article.

Features of A Debenture

Debentures are not backed by any securities. They are not secure, and an investor invests in them solely based on the reputation and creditworthiness of the company. They are issued not just by companies but also by governments to finance specific projects. 

They are long-term investment options, and their maturity term is usually longer than ten years. Few debentures can be converted to equity shares, but this option is not available for all debentures. 

The investor is entitled to periodic interest payments in a debenture, termed coupon payments. The way of interest calculation is specified in the indenture (which can be defined as a legally binding contract between the issuer and investor). 

Debentures issued by the governments are generally considered safer and attract many risk-averse investors. 

Investors who invest in debentures get no voting rights in the company (this is similar to bonds). It means that a company issuing debentures has no impact on the equity structure and does not dilute the firm’s share value.

The maturity date is important while issuing debentures. It is the date on which the borrowing entity (company or government) is supposed to pay the money back to the investors. The company can choose to repay via two methods. It can either make a lump sum payment in the end or pay back the money in instalments for the debenture period.

Types of Debentures

Debentures can be classified into different types as given below:

Based on security

1. Secured debenture: In such debentures, there is an established charge over the company’s assets for payment purposes. This charge can be fixed or floating.

2. Unsecured debenture: There is no charge established on the company’s assets. 

Based on convertibility

1. Convertible debenture: These are the ones that can be changed to any other form of security (mostly equity shares) when required, by the consent of both issuer and investor. Convertible debentures come under the category of hybrid financial instruments, for they offer the advantages of both equity and debt. The investor can either hold it until the maturity period and receive regular interest payments or convert the debenture into equity, which has higher risk but may offer higher returns. 

2. Non-convertible debenture: These are normal debentures that cannot be converted to any other form of security. Here, the interest rates are generally higher than convertible debentures to attract investors because many of them may not be interested in them for low return rates.

Based on coupon rate

1. Specific coupon rate: There is a specific rate of interest that is being paid to the investor on such a debenture.

2. Zero-coupon rate: In such debentures, there is no interest being paid to investors. So the question arises as to how investors make profits. These debentures are issued at a discounted price (a price lower than their actual value) to lure investors. Now, the difference between the discounted price and the nominal value is the profit that investors earn.

Based on registration

1. Registered debentures: These debentures are issued by the company, and the investors’ record is noted down thoroughly. The record includes their name, address, ID proof, and such details. 

2. Bearer debentures: The issuing company does not hold any official record of those who have invested in debentures. They are transferable by delivery. To claim the interest on the debenture, the interest coupon has to be shown to the concerned authorities.

Conclusion

There are various types of debentures that companies can issue. T-bonds are good examples of debentures that the U.S. Treasury Department gives. The floating rate of debentures’ interest is related to specific benchmarks, like the 10-year Treasury bond yield. Now, as the value of the benchmark changes, the floating rate changes as well. While issuing debentures, a company’s credit rating is of utmost interest because the investors’ interest would be directly proportional to the company’s creditworthiness. If a company with a good track record issues a debenture, people would readily invest in them. However, a company with a weak track record would not be able to attract investors.