Difference Between Bonds and Debentures

Every organization requires financing for setting up as well as daily survival. These funds can be set up either by the issuance of debt or equity instruments. Most of the organizations will prefer debt since it does not involve personal funds being utilized and can also be used for leverage. Two of the major sources of funds through the debt route are bonds and debentures.

Though both terms may be used interchangeably but are distinctly different, bonds are essentially loans secured by a specific physical asset. A debenture is a debt security issued by a corporation not secured by assets but by the Credit rating of the organization. This is a preferred instrument by both governments as well as private organizations.

1. A bond is a financial instrument issued for raising an additional amount of capital. These are issued by government agencies and also by private organizations offering periodic interest payment and principal re-payment at the completion of the duration. On the other side, a debenture is an instrument issued by private/public companies for raising capital from the investors. They are not secured by any physical assets or collateral but are backed only by the creditworthiness and reputation of the issuing party.
2. Bonds generally offer a lower rate of interest. The lesser interest offered is an indication of the issuer not requiring money and depicts more stability of repayment in the future. Debentures offer a higher rate of interest in comparison to bonds as they are unsecured in nature.
3. Interest payment on bonds is done on an accrual basis (monthly, semi-annually, or annually) irrespective of the performance of the issuing party. Payment of interest for debenture holders is done on a periodical basis, depending on the financial performance of the company.
4. With respect to the above, the risk factor in bonds is substantially less in comparison to debentures.
5. At the time of liquidation, bondholders are given a priority in repayment in comparison to debentures.
6. The holder of bonds is termed as bondholders, and that of debentures is debenture holders.
7. Bonds cannot be converted into equity shares, but debentures have this facility.
8. Bonds are generally long-term instruments promising to pay fixed interest over a specific time frame, whereas debentures are a medium-term instrument.
9. Bonds are issued by bidding or private placement models whilst debentures are done via transfers and issuance of mortgages.

As discussed above, both are forms of borrowed capital for companies and are widely practiced since it is a form of debt for the issuing company, which gives them the benefit of not deploying personal funds. There are various types of bonds and debentures, and an investor can invest their money depending on the preferences and risk-taking ability. Bonds are relatively more secured since they are predominantly issued by government agencies, and bonds are also vetted by credit rating agencies allowing careful decision making. They offer stable returns and are also included in the portfolios of investors.

Debentures are also a form of credit but less secured since its repayment depends on the credentials of the issuer in the market. These instruments are considered superior to equity shares and thus can get stable returns on being creditors to the companies, but it depends on the willingness of the investors and the broader macroeconomic situation prevailing in the country.

Thus, all Debentures are Bonds, but all the bonds are not Debentures.

This has been a guide to Bonds vs. Debentures. Here we discuss the top differences between Bonds and Debentures along with infographics and the comparison table. You may also have a look at the following articles on accounting to learn more about fixed income -

• Treasury Bills vs. Bonds Differences
• Callable Preferred Stock
• Bond vs. Loan Differences