Every business at some point of time needs funds for its growth and expansion. There are many ways through which money can be raised for business. Among those methods the two ways includes issuing debentures and bonds. Both of these fixed income securities are confused to be the same by some people, but there is a slight difference between debentures and bonds which we will cover in detail in this article.
Key Takeaways
- Bonds can be secured or unsecured whereas Debentures are unsecured debt instruments.
- Bonds can be issued by any organization whereas debentures are typically issued by companies with strong creditworthiness and good financial strength.
- Due to lack of collateral, debentures are generally considered riskier than secured bonds
- Debentures have a longer or perpetual maturity period whereas bonds often have a fixed maturity date.
- Bonds are prevalent globally whereas debentures have domination in United States more than rest of the world.
Understanding Debentures and Bonds
Debentures and bonds are both fixed-income securities that give regular interest to investors. But, they have some key differences that will be discussed in this article.
Defining Debentures
A debenture is a type of unsecured debt instrument which is issued without taking any collateral in return. Big companies or governments issue debentures to raise money for further investment purposes. People who buy debentures lend money to the issuer of that debenture whether its a private company or government. The money which is raised against the debenture is paid with interest when the amount is due to the issuer.
Debentures are generally issued by large companies to meet the expense requirements of the ongoing project or to pay for the planned expansion of business. Debentures are the most common source for long tern funding by the big corporations.
Debentures often carry a fixed or floating rate of interest paid to the investor on the due date. While distributing profits of excess income, the the repayment of interest on debentures comes the first, even before the declaring or distributing dividends among the shareholders.
The payment of debentures can either be made in lumpsum or in yearly installments and decided in the agreement. If the repayment is due by the means of installments then this is generally know as debenture redemption reserve.
There are generally two types of debentures – convertible and non-convertible debentures. Debentures which can be converted into teh company stocks are known as convertible debentures. Generally the rate of interest is low on convertible debentures and companies do prefer to get such of debentures on priority.
What are Bonds?
Bonds are another type of fixed-income securities. It can be either secured or unsecured which means it can be backed by a collateral. Governments, cities, and companies issue bonds for different needs, like funding projects, growth and development in the company etc.
Bond is another type of debt insutrument which is very common among private institutions, companies and government institutions. The investor issues a loan in return of the bonds from the company and the company or the government institution also promises to repay the loan on the due date or on the maturity of the bond.
Bonds are considered to be the safest investment options in the investors world. Bonds carry a guarenteed rate of return which is generally lower than the other investment options but are secured in terms of repayment and timely receipt of interest payment.
Some people might think that the due to lack of security a debenture is considered riskier than the bond, but this is not the case.
Why Companies Issue Bonds?
This is a debated question why companies issue bonds to raise capital instead of borrowing money directlly from a bank.
Companies issue bonds to raise capital for their business and keeping promits in mind, these corporations issue bonds which is pay a less amount as interest to the investors than what they had to pay for a bank loan. Usually the rate of interest on a bond is less than the rate of interest that is offered on a bank loan.
By getting the loan at a low rate of interest companies able to invest actively in the growth projects. Issuing bonds also comes with the freedom to operate the business at per its own will and without any restrictions on expansion and growth as in case of bank loans, they do not agree for raising more debt and do any type of merger or acquisition.
Issuing bond by the corporations attracts large number of investors and it is very easy to keep a track as the interest paid and maturity date are same for all the money lenders or investors.
The interest rate on bonds depends on the credit quality and duration for which the bond is issued. The maturity period of bonds depend of the company and the period can vary from 1 month to as long as 30 years or even perpetual which means the investor will get the interest lifetime.
What is the Difference Between Corporate Bond and Government Bond?
Corporate bonds are issued by private corporations to fund their growth and expansion or day to day business needs whereas government bonds are issued by government to fund for infrastructure projects, development projects, paying salaries to employees etc.
The corporate bonds are generally riskier than the government bonds as governemnt is less likely to fail in making their payments on due date. Therefore corporate bonds give a higher rate of interest than government bonds due its risk factor.
Before making any investment plan in any of the investment opportunities whether in government bonds or corporate bonds always take care of the maturity period, rate of interest and the credibility of that organisation.
Conclusion
For private companies and government departments, issuing bonds comes with the opportunity to raise easy money from the public without diluting any ownership of the company. There are different varieties of bonds available in teh market ranking from different maturity period and rate of interest.
Due to the wide variety of investment options, the investors must come prepared with the research on the companies offering these bonds, so that they can decide where to invest their money and also check previous records of the company and the average rate of interest offered by the company.
For investors who are not so educated in financial markets can take help from financial professionals in understanding where to invest their money and also the risks involved in investing in corporate of government bonds. The major risks involved are of the rising rate of interest and the company going bankcrupt. In case the company goes bankcrupt, then the investor can loose his partial or the whole money.
