Before we can begin to understand the differences between bonds and debentures, let us first try to understand what the terms mean. After all, both are fixed income instruments.
Bond – A bond is a debt investment or a debt security that runs a fixed term. The creditor holds the bond and is the money lender. The issuer is the borrower and has to pay interest on the money borrowed as per the terms of the bond.
Debenture – A debenture is an unsecured debt. There is no collateral in a debenture. Debentures are issued by businesses to raise capital for short to medium term expenses.
Let us now look at these two financial instruments in a little more detail.
Bonds are issued in the primary markets by companies, governments, and public authorities. Bonds are underwritten by a securities firm. This means that if the bond issuer defaults there are always assets [that the issuer has placed as collateral] to be claimed in lieu of payment default. Bonds, thus, are secure. Because these are secure they make for an excellent long-term investment. The rate of interest may not be very high as compared to stocks and debentures, but you know what you’ll be getting and you can be sure that you’ll get it. You can trade in bonds through bond funds. Bonds are transferable. Interest on some bonds such as registered bonds in America is paid together with the principal amount upon maturity.
As mentioned earlier, debentures constitute an unsecured debt given individuals and business entities to companies that are looking to raise money. If the company defaults on the debt, you don’t have access to any underlying assets. Because the exposure to risks is high, debentures offer higher rates of interest. With a debenture, the company is not necessarily going to return the principal amount on maturity. Also, unlike shares a debenture certificate does not give you any right of ownership on the company. In case, a company faces liquidation debenture holders come after bond holders in the queue for return of capital invested.
09 July 2012
A debenture is a debt security issued by a corporation that is not secured by specific assets, but rather by the general credit of the corporation. Stated assets secure a corporate bond, unlike a debenture, but in India these are used interchangeably.
Bonds are lOUs between a borrower and a lender. The borrowers include public financial institutions and corporations. The lender is the bond fund, or an investor when an individual buys a bond. In return for the loan, the issuer of the bond agrees to pay a specified rate of interest over a specified period of time.
Typically bonds are issued by PSUs, public financial institutions and corporates. Another distinction is SLR (Statutory liquidity ratio) and non-SLR bonds. SLR bonds are those bonds which are approved securities by RBI which fall under the SLR limits of banks.
Underwriting can also refer to the purchase of corporate bonds, commercial paper, government securities, municipal general-obligation bonds by a commercial bank or dealer bank for its own account or for resale to investors. Securities firms purchase/underwritten these bond and sale them in market.
In acting as an intermediary between a bond issuer and a bond buyer, the investment banker serves as an underwriter for the bonds. When investment bankers underwrite the bonds, they assume the risk of buying the newly issued bonds from the corporation or government unit; they then resell the bonds to the public or to dealers who sell them to the public. The investment bank earns a profit, based on the difference between its purchase price and the selling price; this difference is sometimes called the underwriting spread.
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