Simply, a debenture is nothing but a type of bond or other debt instruments, which will be backed by collateral. Investors can find debentures from both corporations and governments. Debentures are documented in an indenture, which is a legal and binding contract between the bond issuers and the bondholders. Debentures are issued by governments or corporates, usually for more than 10 years (long-term bonds), to raise capital.
Interest and features of debentures
At the time of the debenture contract, the investor or the bondholder will be informed about the debt offerings, like maturity date, the interest rate, the timing of interest or coupon payments, method of interest calculation, etc.
Debentures pay a particular interest rate that is redeemable or repayable on a fixed date. Before paying stock dividends to its shareholders, the debenture issuing company will fix the scheduled debt interest payments. Debentures can give periodic interests, as coupon payments. The coupon rate can be fixed or floating.
Debentures are preferred instruments by the companies because, the debentures will have lower interest rates and longer repayment dates, compared to other types of loans or debt instruments.
Convertible and non-convertible: Types of debentures
Some debentures can also convert to equity shares, but not all of them. Depending on that feature, debentures are categorized as convertible and non-convertible debentures. The convertible debentures will be able to convert into equity shares of the issuing corporation, certainly after a specific time. It is a gain for the debenture-holders. Similarly, non-convertible debentures or traditional debentures will not be able to convert into equity shares. In this type, the debenture-holders get higher interest rates, than convertible debentures, as compensation.
Investors can prefer governments issued long-term bonds, which are low-risk investments, with the back-up by the government. That will certainly depend on the risk appetite of the investors. On the other hand, the debentures issued by corporations, are unsecured. The investors will have to rely on the financial viability and creditworthiness of the corporation, issuing the debenture.