Whether it may be a small enterprise, an established company or the Government itself, the need for money to make it run is ever accepted. Borrowing is one of the most common ways of availing the needful fund. There are many ways different ways to borrow money among which Bonds and Debentures are the prominent ones.
A bond and debenture both are debt instrument issued by government or companies. Both of these are fundraising tools for the issuer. Bonds are generally issued by the government, the agencies of government or by large corporations whereas debentures are issued by public companies to raise money from the market. Sometimes both the words are used interchangeably but both are distinctly different. Let’s understand both the investment tools and how they are different from each other.
What is a Bond?
A bond is a financial instrument which shows the obligation of the lender towards the borrower. A bond is actually a certificate proofing the contract of indebtedness of the issuing company for the amount that the borrower owes to pay to the bondholders.
A bond is a secured investment as it is secured by collaterals. In bonds, an asset is pledged as the security of lending so that if the issuer fails to pay the sum, the bondholders can sell the asset to discharge their debts.
Bonds are issued for a fixed period. The interest on a bond is paid in regular intervals which are called coupons. Let’s say you have bought a bond of Rs.10,000 for 5 years at the interest of 10%. So at the end of every month, you will receive a coupon of Rs.1000 and at the end of the period, you will get your Rs. 10,000 back. A bond sometimes can be used as a regular source of income for retired persons. The future date on which your bone period will be over is known as maturity date.
What is a Debenture?
A debenture is another form of debt fund which is generally unsecured in nature. Both the bonds and debentures are fundraisers but debentures are more specific in nature. Debentures are not backed by any of the assets of the issuer hence depends only on the faith factors of the investor on the issuer. Debentures are issued by the issuer for any specific need such as upcoming expenses or to pay for expansions. The capital raised here is borrowed capital hence the debenture holders are treated as creditors of the company.
Bond Vs Debenture – The Key Differences
Some of the prime differences between bonds and debentures are as follows
- Bonds are the financial instruments issued by Government agencies and also by Private organizations for raising additional fund from the public. Debentures are issued by private/public companies for raising capital from the investors.
- Bonds are backed by the asset of the issuer whereas debentures are not secured by any of the physical assets or collateral. Debentures are issued and purchased only on the creditworthiness and reputation of the issuing party.
- The interest rate of bonds is generally lower than debentures. The lower interest rate depicts the low-risk factor. On the other hand, debentures give you a high-interest rate but they are unsecured in nature hence the risk factor is more here.
- The interest on a bond is given to the bondholder in monthly, half-yearly or annually. The interest amount never differs as the interest paid is not depended on the performance of the issuer. Adversely, if you buy debentures, your interest rate may be high but the interest payment will be periodic depending on the performance of the issuer.
- There is no to the minimum risk involved in bond investments but the risk factor is high in debentures.
- At the time of liquidation, the bondholders are always given preference.
- If you own bonds, you can never convert it to equity shares, but debentures can be transferred to equity funds.
A bond and a debenture both are forms of borrowed capital but the difference comes in the nature of both the instruments. A bond is backed by collateral while a debenture is not. But the scope of earning is always high with debentures. If you have the ability to gauge the creditworthiness of the provider of the debentures, you can definitely buy debentures for a better profit. But if you are new to the field of investment then bonds are a better choice for you. Bonds are relatively more secured as they are issued by Government agencies hence the returns are granted here. But if your risk appetite is high and wants to earn a better profit in less time, debentures will work better for you.