Definition
A debenture is an unsecured note or bond issued by a corporation or government entity to raise funds. Unlike secured debts, debentures are not backed by any physical collateral and rely solely on the creditworthiness and reputation of the issuer. Debentures typically have a fixed interest rate and are repayable at a predetermined future date, known as the maturity date.
Examples
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Corporate Debenture: XYZ Corporation issues debentures to the public to raise capital for expansion. These debentures have a fixed interest rate of 5% per annum and a maturity period of 10 years. Investors who purchase these debentures trust XYZ Corporation to meet its financial obligations based on its credit rating and history.
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Government Debenture: A government entity issues debentures to fund infrastructure projects. Investors buy these debentures with the expectation that the government will honor its repayment commitments based on its ability to generate revenue from taxes and other sources.
Frequently Asked Questions
Q1: What is the main difference between a debenture and a secured bond?
A1: The main difference is collateral. A debenture is not backed by physical assets or collateral, whereas a secured bond is supported by assets that can be claimed by creditors in case of default.
Q2: How is the interest rate on a debenture determined?
A2: The interest rate on a debenture is typically influenced by the credit rating and risk profile of the issuer, the prevailing market interest rates, and the length of the maturity period.
Q3: Are there risks associated with investing in debentures?
A3: Yes, debentures carry credit risk since they are unsecured. In case the issuer defaults, debenture holders may receive little to no repayment. The risk level depends on the financial health of the issuer.
Q4: Can investors trade debentures in secondary markets?
A4: Yes, debentures can be traded in secondary markets. Their value in the secondary market depends on factors such as changes in interest rates, the credit rating of the issuer, and the remaining time to maturity.
Q5: Do debentures always have a fixed interest rate?
A5: No, while many debentures offer a fixed interest rate, some debentures come with a floating rate where the interest rate can change according to a benchmark rate or index.
Related Terms with Definitions
- Bond: A debt instrument where an issuer borrows money from investors and promises to pay back the principal along with interest on specified dates.
- Creditworthiness: The assessment of a borrower’s ability to repay debts, often evaluated through credit ratings.
- Collateral: An asset pledged by a borrower to secure a loan or debt, which can be claimed by the lender in case of default.
- Maturity Date: The date on which the principal amount of a debt instrument, such as a debenture, is due to be paid back in full to the investor.
- Default: The failure to meet the legal obligations or conditions of a loan, typically the non-payment of the principal or interest.
Online Resources
- Investopedia’s Guide to Bonds and Debentures: Investopedia – Bonds vs. Debentures
- Securities and Exchange Commission (SEC) – Investor Information: SEC – Bond Basics
References
- Investopedia. “Bond vs. Debenture: An Overview.”
- Securities and Exchange Commission (SEC). “Investor Publications.”
Suggested Books for Further Studies
- “The Bond Book: Everything Investors Need to Know About Treasuries, Municipals, GNMAs, Corporates, Zeros, Bond Funds, Money Market Funds, and More” by Annette Thau
- “Bond Markets, Analysis, and Strategies” by Frank J. Fabozzi
- “Investing in Bonds For Dummies” by Russell Wild
- “Fixed Income Analysis” by Barbara S. Petitt and Jerald E. Pinto
