The debenture is a negotiable promissory bearer note whose value is based on the creditworthiness of the debtor. As an indenture, the debenture will list the beginning date, interest rate, maturity date, callable features and parties to the agreement.
A debenture is a debt not backed by any collateral. In many countries, the name is synonymous with a government or corporate bond. There are subtle differences in how the the debenture is structured in different countries.
“Most Creditors Want Loans Backed by Collateral”
While everyone would probably like to create a debenture (receiving a loan with no collateral backing it up), the reality is that usually only governments and the top multinational corporations have good enough credit ratings to qualify. They are considered to have a low risk of default.
The debenture qualifies as a bearer instrument meaning that it can be exchanged, traded or sold to another party. The “bearer” has the right to the money promised in the debenture. Possession is nine-tenths of the law.
“Low to No Risk”
In the financial industry, sovereign states (national governments) are usually deemed to be low risk (or no risk). Paper money can be printed or citizens can be taxed to pay off debts. In fact, no entity within a nation can have a higher credit rating than the national government.
The United States Treasury bond (T-bond) or Treasury bill (T-bill) is considered to be a debenture. Just like your Federal Reserve Note (United States Dollar) it is based on your trust in the full faith and credit of the United States government. Fiat currency is a debenture because it has nothing physical or tangible backing it.
“Features of Debentures”
The primary creators of debentures are governments or corporations. Here are the primary features of debentures:
- Sinking Fund
The callable debenture can be paid off before its maturity date. The convertible debenture can be changed from a bond to equity shares (stocks); the non-convertible debenture cannot. With the sinking fund debenture, the debtor makes periodic payments, just like a mortgage.