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A debenture is a form of debt instrument used by companies for borrowing money. In the US a debenture is not backed by any physical asset or collateral; rather, it is secured on the borrower’s reputation and credit history. In the UK, in contrast, a debenture is based on the asset of the borrower.
A Little More on What is a Debenture
So practically it is a kind of bond issued by both the corporate houses and governments to secure funds. It is a certificate of loan that ensures the company is liable to pay the stated amount with interest.
In the U.S., the government issues debentures in form of Treasury bonds or Treasury bills. The buyers buy these bonds based on the trust that the government won’t fail to pay back the amount with interest. There is no collateral involved in these.
Debentures are the most common form of long-term loan taken by corporations with a fixed rate of interest and a fixed date of repayment. Usually, the corporations pay the interests of debentures before paying the dividends to its shareholders.
Debentures are generally issued by the big corporations as they have reputation and reliability. In the U.S., the corporations issue debentures of around $1,000. For issuing a debenture, an agreement is signed between the issuing company and a trust that manages the interest of the prospective debenture holders. It is documented in an indenture. After that the interest rate of the debentures is decided, the rate can be fixed or variable.
Convertible and Nonconvertible Debentures
There are two types of debentures convertible and nonconvertible. The convertible debentures can be converted into equity share of the issuing company after a specific period of time, whereas the nonconvertible debentures do not have any such provisions. The interest rates of the nonconvertible bonds are higher than the convertible bonds.
In the case of nonconvertible debentures, the company pays back to the debenture holder on the date of maturity. There are two ways of repaying the debenture holder depending on the terms of the bond. The most common way is paying a lump sum amount on the maturity date, it is called a redemption out of capital. The second option is paying a specific amount of fund yearly to the debenture holder until the whole amount is repaid on the date of maturity. It is known as debenture redemption reserve.
References for Debenture
Academic Research on Debenture
· Evidence of bank market discipline in subordinated debenture yields: 1983–1991, Flannery, M. J., & Sorescu, S. M. (1996). The Journal of Finance, 51(4), 1347-1377. This study looked at the yields of debentures (long-term, unsecured debt issued by governments and companies) from 1983-1991 and found that investors responded rationally to increased risk levels among banks.
· Debenture Holders and the Indenture Trustee: Controlling Managerial Discretion in the Solvent Enterprise, Robertson, S. M. (1988). Harv. JL & Pub. Pol’y, 11, 461. This paper examines the relationship between holders of debentures (long-term, unsecured corporate debt) and corporations.
· A Borrower’s View of the Model Corporate Debenture Indenture Provisions, Garret Jr, R. (1965). Bus. Law., 21, 675. This paper examines the attitudes of borrowers toward debenture indentures—the binding contracts between issuers of certain unsecured debts and buyers of that debt. The paper discusses the excessive length and complexity of these contracts.
· The Effect of Provision for Ratable Protection of Debenture Holders in Case of Subsequent Mortgage, Jacob, F. W. (1938). Harv. L. Rev., 52, 77. This paper looks at debentures—long-term, unsecured debt—in relation to equity investments.
· Thoughts on Our Debenture Market [J], De-xu, H., & Wu, L. (2002). Financial Theory and Practice, 8, 000. Debenture is long-term unsecured debt issued by governments and corporations. This paper examines the reasons for China’s relatively small debenture market, and offers suggestions to promote the growth of that market.
· The Yield on a Debenture bought at a premium, Craig, J. I. (1929). Journal of the Institute of Actuaries, 60(3), 341-345. This paper compares different methods for determining the yield of a debenture, a long-term unsecured debt, sold at a price greater than its nominal value.
· Comparison of JGB and bank debenture credit spread models, Miyazaki, K., & Tsubaki, H. (1999). The Journal of Fixed Income, 9(1), 63-70. This paper offers a way to model interest rates and credit spreads (the markup in interest rates for corporate debt) in the Japanese bond market.
· What is a Convertible Debenture? A Review of the Literature in the USA, Clancy, D. K. (1978). Abacus, 14(2), 171-179. This literature review seeks to clarify alternative definitions of convertible debenture. Specifically, the author considers whether convertible debenture qualifies as debt or equity.
· The Corporate Debenture System of South American Countries, Cappa, V. E. (1933). Yale LJ, 43, 571. This paper examines the adoption of the Anglo-American corporate finance practices and legal system on the Latin-American system.
· The Importance of Economic Reality and Risk in Defining Federal Securities, Hannan, J. T., & Thomas, W. E. (1973). Hastings LJ, 25, 219. This article offers insight into the definition securities as laid out by federal statute and case law.
· Bond covenants and creditor protection: Economics and law, theory and practice, substance and process, Bratton, W. W. (2006). European Business Organization Law Review (EBOR), 7(1), 39-87. This article examines the different ways that creditors can protect themselves from risky borrowers. Its primary focus is on incorporating protections into contracts between creditors and borrowers.