A debenture is a debt instrument, which is not backed by collateral’s. Debentures are backed by the creditworthiness and reputation of the debenture issuer. Besides, a debenture is a long-term debt instrument issued by governments and big institutions for the purpose of raising funds. The debenture has some similarities with bonds but the terms and conditions of securitization of debentures are different from that of a bond. A debenture is regarded as an unsecured investment because there are no pledges (guarantee) or liens available on particular assets. Nonetheless, a debenture is backed by all the assets which have not been pledged otherwise.
Normally, debentures are referred to as freely negotiable debt instruments. The debenture holder functions as a lender to the issuer of the debenture. In return, a specific rate of interest is paid to the debenture holder by the debenture issuer similar to the case of a loan. In practice, the differentiation between a debenture and a bond is not observed every time. In some cases, bonds are also termed as debentures and vice-versa.
If a bankruptcy occurs, debenture holders are treated as general creditors. The debenture issuer has a substantial advantage from issuing a debenture because the particular assets are kept without any encumbrances so that the option is open for issuing them in future for financing purposes. Usually, debentures are categorized into the following types and their definitions are also given below:
- Convertible Debenture: 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.
- Non-convertible debenture: Simply regular debenture 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.
- Corporate Debenture: Debentures issued by companies and they are insecure in nature.
- Bank Debenture: This type of debentures is issued by banks.
- Government Debenture: This includes Treasury Bond (T-Bond) and Treasury Bill (T-Bill) issued by the government. They are usually regarded as risk-free investments.
- Subordinated Debenture: This is a particular type of debenture, which ranks below regular debentures, senior debt, and in some instances below specific general creditors.
- Corporation Debenture: Corporation debentures are issued by various corporations.
- Exchangeable Debenture: They are like convertible debentures, but this debenture can only be converted to the common stock of a subsidiary company or affiliated company of the debenture issuer.