A LOT more people should know about debentures than do. Simply put, a debenture is a bond that instead of being secured by property or capital asset is rather secured only by the “general credit-worthiness” of the issuer. Hmmm… that’s a bit of a mouthful, so let me break it down…
If a bond defaults, the bond-holders are entitled to the liquidated proceeds of the property or equipment that was bought with the money that was given to the bond issuer in exchange for the bond. Think of it like a mortgage – if you default on your mortgage, the bank can sell your house to recoup it’s money.
A debenture is just like a bond in all ways except for what is pledged as security for the investment. With a bond, the security is property. With a debenture, the security is only the “credit-worthiness” of the issuer. So if they have a AAA credit rating, they are in excellent financial shape. But if they default, or go under, the debenture holder has no property rights per se.
So, why buy a debenture? As you are probably becoming more conscious of: since the debenture is slightly riskier, a rational investor would expect a higher rate of interest than with a bond which has more “security”. So if you are looking at buying a bond from Company XYZ, you will see that if they offer debentures as well, they offer a higher rate of interest than the bond (of comparative length).