Debenture Definitions
I am looking to define debenture for a general audience who has little to no education about corporate finance. Imagine a situation where you are an individual investor thinking about options for an optimal rate of return.
Parenthetical Definition: Loans issued by corporations and governments.
Sentence Definition: Debentures are long-term loans issued by companies or governments, that are backed by general creditworthiness instead of specified assets. These kinds of loans are used to raise money and are also known as unsecured debt, because they depend on the reputation of the issuer instead of physical assets or collateral.
Expanded Definition: A debenture is a written acknowledgement of indebtedness by the company setting out the terms and conditions of the loan. This definition will explain their purpose, typical features, some pros and cons, and an example.
There are two main purposes for debentures. For companies and governments, they are a means to raise capital or funds for many different purposes. For investors, debentures offer periodic interest payments called coupon payments. They are usually seen as a long-term, low risk assessment, especially if the issuer is a government.
Figure 1. The process of a debenture starts with the corporation or government entity of the far left – and moves clockwise.
When a debenture is issued, there are several characteristics that must be looked at.
Interest Rate: The rate of interest that the company or government will pay the investor.
Credit Rating: Depending on the creditworthiness of the corporation or the government, investors will assess their risk. If they have a history of not paying back their debts, they are riskier and more speculative.
Maturity Date: The maturity date dictates when the company must pay back the investors. This can be done in several ways; paid out in full at the end of the term, or in specific amounts each year.
Pros: A debenture pays a regular interest rate to investors.
Cons: Debentures do carry some risk. If the company is not secure or struggle financially, investors are at risk of losing their money.
An example of a debenture would be a U.S. Treasury bond. They are used to finance projects and fund governmental operations. While they face the risk of inflation, most investors have faith in the U.S. government and don’t think they will go bankrupt (this unlikely event would devalue the treasury bills).
Sources
“What is a debenture.” BDC.ca. https://www.bdc.ca/en/articles-tools/entrepreneur-toolkit/templates-business-guides/glossary/pages/debenture.aspx.
Chen, James. “Debenture.” Investopedia, Feb 25th, 2020. https://www.investopedia.com/terms/d/debenture.asp.
“What is a debenture?” IG.com. https://www.ig.com/en-ch/glossary-trading-terms/debentures-definition
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