What is a Debenture?

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). 

 




Preet Banerjee
Preet Banerjee
...is an independent consultant to the financial services industry and a personal finance commentator. You can learn more about Preet at his personal website and you can click here to follow him on Twitter.
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Showing 4 comments
  • kannan

    Can debenture appreciate?

  • Preet

    Yes, a debenture can appreciate in exactly the same way a bond can. (It can also depreciate in exactly the same way a bond can.

    The best way to think about a debenture is to view it like a bond that, instead of being secured by physical property or equipment, is secured only by the general credit worthiness of the issuer.

    In other words, it is a riskier asset than a bond from the same issure because if the company becomes insolvent, the bondholder gets the proceeds from the sale of the capital property the bond is secured against, but the debenture holder has no claim.

    Because of this increased risk, the debenture of similar term from an issuer who also has a bond of similar term will get a higher rate of interest than the bond pays.

    Preet

  • Mario Osti

    Why would a company with stable financing and good revenue flow buy back their own debentures?

  • pamela kay m

    i have an old debenture of the “A” series from the East St. Louis Land Company, Limited
    dated August 3rd., 1892 been in family long time , just found in some papers. Does it have any value? thank you for your response. sincerely, pamela kay m