What is the difference between Bonds and Debentures?
Financing is the basic requirement of every big and small-sized organization. Funds can be raised by issuing debt or equity instruments. When it is about debt instruments, two major sources of raising external finance are used by the companies; are Bonds and Debentures. In many countries, they are supposed to be one but the two terms differ in many regards. Bonds are generally issued by government agencies and large corporations, but public companies issue debentures, to raise money from the market.
Bonds and debentures are two financial assets which are issued by the borrowing company, for a price which is equal to, less than or more than its face value, but they are not one and the same. There are many differences between bonds and debentures which are discussed in tabular form, in this article below. Have a look.
Bonds are the most frequently referenced type of debt instrument, An investor loans money to an institution, such as a government or business; the bond acts as a written promise to repay the loan on a specific maturity date. Normally, bonds also include periodic interest payments over the bond’s duration, which means that the repayment of principal and interest occur separately. Bond purchases are generally considered safe, and highly rated corporate or government bonds come with little perceived default risk.
Bonds and stocks are both securities, but the major difference between the two is that (capital) stockholders have an equity stake in a company (i.e., they are owners), whereas bondholders have a creditor stake in the company (i.e., they are lenders). Being a creditor, bondholders have priority over stockholders. This means they will be repaid in advance of stockholders, but will rank behind secured creditors in the event of bankruptcy. Another difference is that bonds usually have a defined term, or maturity, after which the bond is redeemed, whereas stocks typically remain outstanding indefinitely. An exception is an irredeemable bond, such as a console, which is a perpetuity, that is, a bond with no maturity.
In corporate finance, a debenture is a medium to long-term debt instrument used by large companies to borrow money, at a fixed rate of interest. The legal term “debenture” originally referred to a document that either creates a debt or acknowledges it, but in some countries the term is now used interchangeably with bond, loan stock or note.
A debenture is thus like a certificate of loan or a loan bond evidencing the fact that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company’s capital structure, it does not become share capital. Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoff for these categories.
Debentures are generally freely transferable by the debenture holder. Debenture holders have no rights to vote in the company’s general meetings of shareholders, but they may have separate meetings or votes e.g. on changes to the rights attached to the debentures. The interest paid to them is a charge against profit in the company’s financial statements.
Bonds and debentures provide companies and governments with a way to finance beyond their normal cash flows. Some debentures and bonds are convertible, which means that they can be converted into company stock. In a sense, all debentures are bonds, but not all bonds are debentures. Whenever a bond is unsecured, it can be referred to as a debenture.
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