Financing is the basic requirement of every big and small-sized organization. Funds can be raised by issuing debt or equity instruments. When it is about debt instruments, two major sources of raising external finance are used by the companies; are Bonds and Debentures. In many countries, they are supposed to be one but the two terms differ in many regards. Bonds are generally issued by government agencies and large corporations, but public companies issue debentures, to raise money from the market.
Bonds and debentures are two financial assets which are issued by the borrowing company, for a price which is equal to, less than or more than its face value, but they are not one and the same. There are many differences between bonds and debentures which are discussed in tabular form, in this article below. Have a look.
Content: Bonds Vs Debentures
|Basis for Comparison||Bonds||Debentures|
|Meaning||A bond is a financial instrument showing the indebtedness of the issuing body towards its holders.||A debt instrument used to raise long term finance is known as Debentures.|
|Collateral||Yes, bonds are generally secured by collateral.||Debentures may be secured or unsecured.|
|Issued by||Government Agencies, financial institutions, corporations, etc.||Companies|
|Priority in repayment at the time of liquidation||First||Second|
Definition of Bonds
A financial instrument which shows the obligation of the borrower towards the lender is known as Bond. They are created to raise funds for the company or government. It is a certificate, signifying a contract of indebtedness of the issuing company, for the amount lent by the bondholders.
In general, bonds are secured by collateral, i.e. an asset is pledged as security that if the company fails to pay the sum within stipulated time, the holders can discharge their debts by seizing and selling the asset secured.
Bonds are issued for a fixed period, which carries interest known as ‘coupon.’ The interest needs to be paid at regular intervals, or it will accrue over time. They are issued by public sector undertaking, government firms, large corporations, etc. The issue of government bonds is done in auctions where members bid for the bonds. The principal amount of the bonds is to be paid at a future specified date known as maturity date. Some common types of bonds are as under:
- Zero coupon bonds
- Double option bonds
- Option bonds
- Inflation bonds
- Floating rate bonds
- Euro bonds
- Foreign bonds
- Fully Hedged bonds
- Euro convertible zero bonds
- Euro bonds with equity warrants.
Definition of Debentures
A debenture is a debt instrument used for supplementing capital for the company. It is an agreement between the debenture holder and issuing company, showing the amount owed by the company towards the debenture holders. The capital raised is the borrowed capital; that is why the status of debenture holders is like creditors of the company.
Debentures carry interest, which is to be paid at periodic intervals. The amount borrowed is to be repaid at the end of the stipulated term, as per the terms of redemption. The issue of debentures publicly requires credit ratings. Debentures are classified in the following categories:
- On the basis of Security
- Secured Debentures
- Unsecured Debentures
- On the basis of Convertibility
- Convertible Debentures
- Nonconvertible Debentures
- On the basis of Negotiability
- Registered Debentures
- Bearer Debentures
- On the basis of Permanence
- Redeemable Debentures
- Irredeemable Debentures
- On the basis of Priority
- First Mortgage Debentures
- Second Mortgage Debentures
Key Differences Between Bonds and Debentures
The following are the major differences between bonds and debentures:
- A financial instrument issued by the government agencies, for raising capital is known as Bonds. A financial instrument issued by the companies whether it is public or private for raising capital is known as Debentures.
- Bonds are backed by assets. Conversely, the Debentures may or may not be supported by assets.
- The interest rate on debentures is higher as compared to bonds.
- The holder of bonds is known as bondholder whereas the holder of debentures is known debenture holder.
- The payment of interest on debentures is done periodically whether the company has made a profit or not while accrued interest can be paid on the bonds.
- The risk factor in bonds is low which is just opposite in the case of debentures.
- Bondholders are paid in priority to debenture holders at the time of liquidation.
Bonds and Debentures both are types of borrowed capital. The major difference between these two debt instruments is bonds are more secure as compared to debentures. The creditworthiness of the issuing company is checked in both the cases. These are the liability of the company that is why they get preference of repayment in the event of winding up of the company.