Bonds and debentures are both debt instruments used by companies to raise capital. While they might sound similar, they have distinct characteristics. Let's delve into the key differences between these financial instruments.

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What are bonds?

Bonds are financial instruments representing a loan made by an investor to a borrower, typically a company or government to raise funds for their operations. The issuer of the bond promises to pay the bondholder periodic interest payments and to return the principal amount at a specified maturity date. There are two types of interest, one is variable and the other is fixed rate. 

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What are debentures?

Debentures often have a more defined purpose than other bonds. While both raise capital, debentures are typically issued to fund specific projects or planned business expansions. These debt securities are a common form of long-term corporate financing. Debentures offer either a floating or fixed interest rate and have a specified repayment date. Companies usually prioritize paying debenture interest before distributing shareholder dividends when interest payments are due.

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Difference Between Bonds and Debentures

Bonds and debentures are both debt instruments used by corporations and governments to raise capital. Here are the key differences between them:

1. Definition:

• Bonds: Bonds are debt securities issued by corporations, municipalities, states, and sovereign governments to finance projects and operations. They typically have a fixed interest rate and a fixed maturity date.
• Debentures: Debentures are a type of debt instrument that is not secured by physical assets or collateral. They are backed only by the general creditworthiness and reputation of the issuer.

2. Security:

• Bonds: Bonds can be secured or unsecured. Secured bonds are backed by specific assets as collateral, providing more security to bondholders.
• Debentures: Debentures are generally unsecured, relying on the issuer's creditworthiness rather than specific collateral.

3. Interest Rates:

• Bonds: Bonds usually offer a lower interest rate compared to debentures due to the additional security provided by collateral.
• Debentures: Debentures often carry higher interest rates to compensate for the higher risk associated with the lack of collateral.

4. Issuers:

• Bonds: Bonds can be issued by corporations, governments, municipalities, and other entities.
• Debentures: Debentures are primarily issued by corporations.

5. Owner

• Bonds: The owner of a bond called bondholder
• Debentures: The owner of a debenture is called a debenture holder.

6. Convertibility:

• Bonds: Bonds are usually non-convertible. However, some bonds can be converted into stock or other forms of equity under certain conditions.
• Debentures: Debentures can be convertible or non-convertible. Convertible debentures can be converted into equity shares of the issuing company at a later date.

7. Priority in Case of Liquidation:

• Bonds: Bondholders have a higher priority compared to debenture holders in case of liquidation. Secured bondholders are paid first, followed by unsecured bondholders.
• Debentures: Debenture holders are paid after secured bondholders but before equity shareholders in the event of liquidation.

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Who Should Invest in Bonds & Debentures?

Investors who are risk-averse should consider investing in bonds. Bonds are generally considered safer investments compared to debentures. Bonds are also suitable for long-term investment, offering fixed interest payments and the return of the principal at predetermined intervals. They are often backed by collateral, providing additional security, which is the primary difference between bonds and debentures.

On the other hand, debentures can offer higher returns compared to bonds and may be a good option for short-term investments. Ultimately, the choice between investing in bonds or debentures depends on your investment objectives.

In conclusion, understanding the differences between bonds and debentures is crucial for making informed investment decisions. Bonds, often secured and offering good interest rates, provide a safer investment option, while debentures, usually unsecured with higher interest rates, may offer higher returns but come with increased risk. 

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