A debenture is a type of corporate bond that is not secured by collateral or specific assets. Debentures are unsecured loans that are backed solely by the financial strength and credit rating of the issuing corporation. Investors can select from several types of debentures based on the issuing company’s credit risk. Investors use information provided by agencies like Moody’s and Standard & Poor’s to verify a company’s credit rating. Debentures offer another way of investing in the bond market.
Debenture bonds carry higher risk because they are an unsecured investment. Investors must examine the corporation’s financial statements to determine if the debenture is a safe investment. Like all bonds, debentures have interest rate risks, which means that the bond loses value if interest rates rise. Since they are unsecured investments, debentures also have a credit risk, which is the danger that the issuing corporation will default on the bonds. In that case, an investor may get some or none of the principal investment back.
A bearer debenture is an unregistered unsecured bond. The issuing corporation does not keep a record of the purchaser’s name, nor is the owner’s name listed on the debenture. The owner cannot get a replacement debenture if the original one is lost or stolen. Whoever finds the bond is presumed to be the owner. Some bearer debentures have coupons that the owner must mail to the issuing corporation to receive interest payments. The maturity date is printed on the bond and can be redeemed up to thirty days from the maturity date.
A mortgage debenture is not a mortgage or a debenture -- it is a bond collateralized by a corporation’s fixed assets. The term "mortgage" does not specifically refer to real estate; it indicates that an asset is pledged to secure the bond issue. A company can use any of its assets, including real estate and equipment, as security. One primary reason corporations issue mortgage bonds is to raise capital to construct new factories or purchase new machinery or equipment. The corporation sells mortgage debentures to the public at a lower interest rate since the bond issue is secured by company assets.
A convertible debenture is an unsecured bond that can be converted into another type of security at a future time. Companies issue convertible debentures to raise capital for large projects and to expand operations. Since the debenture can be converted at a future time, the corporation issues a debenture with a lower interest rate. The terms of the purchase agreement determine the conversion terms, including who can initiate the conversion and when the conversion can occur. The debenture is carried on the balance sheet as a debt until the conversion is made.
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