Sanaya kushwahaFunds are required for any company to establish and grow its business operations. Such companies could include government and well-established companies as well as small enterprises. One of the many ways that companies get funding is through loans.
Bonds and debentures are loans or debt financial instruments that help companies acquire additional capital. Though there might be a potential for a debenture bond debate, there are quite a few differences between the two.
To understand how to evaluate bonds and debentures, let us first look at the basic differences between bonds and debentures.
Difference Between Bonds and Debentures
| Properties | Bonds | Debentures |
| Definition | Debt financial instruments issued by government agencies, financial institutions and big corporations. | Debt financial instruments issued by private companies |
| Tenure | Tenure can last anywhere from below 5 years to over 12 years | Tenure of debentures is comparatively shorter than bonds |
| Risk | Bonds are less risky investments as they are backed by collateral | Debentures are riskier as there is no collateral backing |
| Owner | Known as a bondholder | Known as a debenture holder |
| Collateral | Secured with the help of collateral and physical assets of the issuing company | Unsecure as there is no collateral, and the issuing company’s creditworthiness is considered |
Factors to Consider When Evaluating Bonds and Debentures
For investors to understand how bonds and debentures work, it is important to consider certain factors to evaluate these debt financial instruments. Here is a list of some of them:
Bonds
Four key aspects need to be considered when evaluating a bond’s performance.
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The Price:
One of the main factors to consider is the price of the bond. The return that an investor might receive on the bond will impact the bond price.
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The Interest Rate:
Bonds, till the time they mature, pay a certain amount as interest, either semi-annually or annually. This interest rate is also known as a coupon rate and this interest can either be fixed floating or only payable at the time of maturity. Fixed-interest bonds are the most common and is dependent on a bond’s face value.
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The Yield:
The yield is the return an investor earns on a bond. This is dependent on the bond’s face value and the interest it has generated for the investor.
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The Maturity:
The maturity of a bond is a pre-determined date on which an investor’s principal amount will be repaid by the bond issuer. This could range anywhere from one to 30 years. Bonds with longer maturity have higher interest rate risks due to market fluctuations in the bond price.
Debentures:
Like in bonds, certain features of debentures can help investors evaluate it.
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The Maturity Date:
Similar to bonds, debentures also have a pre-determined maturity date. As a result, investors have clarity on when they can expect their principal amount to be repaid by the issuer.
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The Interest:
Another factor similar to bonds is the interest rate that debentures pay the investors over a fixed timeline. Fixed interest rates stay constant till the debenture’s maturity while variable interest rates can be affected by market fluctuations.
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The Security:
Debentures can be both secure and unsecured. A secure debenture has the backing of the issuer’s assets but provides lower interest rates while an unsecured debenture is riskier as they do not have the asset backing but offers higher interest rates.
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The Transferability:
Bonds cannot be transferred to anyone, other than the legal heir of the bondholder at the time of the latter’s death. Debentures, however, can be transferred as investors can sell, trade or transfer them to another investor in the secondary market. This helps an investor exit the investment if the need ever arises.
Conclusion
Both bonds and debentures are debt financial instruments that help investors earn and open demat account returns by lending funds to companies by investing in them.
Several factors can help evaluate the performance of both bonds and debentures and usually include the instruments’ maturity time, their security aspect and their interest rate, to name a few.
Investors must be aware of these factors and features to help them make the best investment decision and gain high returns at minimal risk.
