It is a debt instrument that is not secured by physical assets, but by the reputation of the issuer, and it gives the right to receive interests and the repayment of the principal (money turned in when buying the debenture). Debentures have a due-date and they give its owner the condition of a creditor. The money raised by the debentures does not become share capital.
A debenture consists of a person/institution lending money to a company.
The company agrees to pay back the lent money along with predetermined periodical interests (coupon); it would be better for the investor to have a higher fixed rate, because this way he/she would be paid more interests. There are different types of debentures, from the point of view of security:
- Secured debentures: debentures secured by a charge to the assets of the company, also called mortgage debentures.
- Unsecured debentures: debentures issued without any charge on assets and they are also called simple or naked debentures.
On the basis of redemption:
- Redeemable debentures: normally, debentures are issued on the condition that they shall be redeemed (paid) after a certain period. After redemption, debentures can be re-issued.
- Irredeemable debentures: there is no specified date of redemption; this means that the debentures can be paid back at any time during the life of the company. They are also called perpetual debentures.
On the basis of records:
- Bearer debentures: debentures registered and payable to the person bearing these debentures. They are transferable and the holder is entitled to get the interest.
- Registered debentures: debentures payable to its registered holder. They can be transferred but the need to be registered again.
- Convertible debentures: debentures that can be converted into shares of the company after a predetermined period of time, by which the holder ceases to be a lender and becomes an owner of the company.
- Non-convertible debentures: debentures that cannot be converted into shares. They usually have higher interest rates than
Convertible debentures. On the basis of coupons:
- Zero Coupon debentures: debentures that do not have specified interest rate, reason why they are issued at a substantial discount.
- Specific Coupon rate debentures: debentures´ rate can be fixed or floating Senior debentures get paid before subordinate debentures, and there are varying rates of risk and payoffs for these categories.