The term debenture bond refers to debt issued by a company that is not secured by collateral. Debenture bonds are a source of capital and would appear as liabilities of the company on the balance sheet.
Also known as certificates of indebtedness, bond debentures are oftentimes used by large companies to raise money. Unlike mortgage bonds, which are backed by physical assets, debentures are unsecured loans. Perhaps the most commonly issued debenture is Treasury Bills, or T-Bills, which are issued by the federal government.
The value of a debenture to investors relies solely on the perceived creditworthiness of the issuing company. For example, a security issued by a company with a bond rating of AAA would be deemed a relatively safe investment.
Within this category of investments, there is also a prescribed payment structure. Senior debentures are paid before subordinate, or junior, securities and the risk of non-payment would increase as subordination increases. For this reason, subordinate debentures would also require the payment of higher interest rates than more senior debt.
Debentures can also be subdivided into two broad categories:
- Convertible: securities that can be converted to shares of the company’s common stock after a pre-determined period of time.
- Non-Convertible: securities that do not contain a convertibility feature.
The convertibility feature of a debenture bond is attractive to investors. Therefore, convertible securities will carry a lower interest rate than their non-convertible equivalent.