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Debenture: Definition, Example and Related Terms

What is a Debenture ?

A debenture is a type of debt instrument that is not backed by collateral but instead by the general creditworthiness and reputation of the issuer. It is a long-term loan arrangement where the issuer agrees to pay a fixed interest rate to the debenture holder until the debt is paid off at maturity. Debentures are commonly used by corporations to raise capital and are typically issued in a certificate form. Without specific assets pledged as security, debenture holders must rely on the issuing company's ability to meet its financial obligations.

Debentures are attractive to investors because they offer a predictable stream of income through interest payments and return of principal upon maturity. However, the absence of physical collateral poses a higher risk compared to secured debt instruments, making the assessment of the company’s creditworthiness crucial.

Corporations prefer issuing debentures because they do not require pledging their tangible assets, allowing them more flexibility and operational stability. Additionally, interest paid on debentures is tax-deductible, offering a tax advantage to companies.

Occasionally, debentures come with additional features such as convertibility and callable options, which can add a unique layer of complexity and opportunity for both issuers and investors.

Example(s)

  • Scenario Description
    Corporate Fundraising A major corporation issues debentures to raise funds for launching a new product line. Investors purchase these debentures with the expectation of receiving regular interest payments and the principal amount at maturity.
    Convertible Debentures A tech company offers convertible debentures which can be converted into shares of the company's stock upon reaching certain conditions, providing investors with a potential upside if the company performs well.
    Callable Debentures A manufacturing firm issues callable debentures, meaning it can choose to repay the principal before the maturity date, allowing the issuer flexibility to capitalize on favorable interest rate changes.

Related terms