Question

what are denbentures and bonds? what are the diffrences, pros and cons of both?

Answer 1

Debentures :

Debentures are generally unsecured debt instruments, that are not covered by any collateral security. A Company which has good credit rating will acts as collateral security. These are issued when a company has cash crunch and also when company is expanding its business with new project.

Bond:

Bonds are generally secured debt instruments that are backed by a physical security. These are generally called as Loans.The holder of the bond is called Lender and issuer of the bond is called as borrower. The lender will receive fixed amount of interest for the entire duration of the bond and also amount will be repaid at the fixed maturity date.

Difference between debentures and bonds:

Debentures	Bonds
Debentures can be secured or unsecured	Bonds are generally secured
These are short term investments	These are long term investments
These are issued by private companies in most cases	These are issued by government agencies, financial institutions and large corporations
Debentures are risky because it is not backed by any collateral	Bonds are generally safe for lenders because these are backed by collateral
It offers high rate of interest	It offeres low rate of interest
Convertible Debentures can be converted to equity shares	Bonds cannot be converted into equity sharss
Interest will be on periodic basis which is based on performance of issuing company.	Interest will be paid on accrual basis like monthly,semi annually an annually

Pros and cons of debentures:

Pros:

1) Financing through debentures are less costly when compared to cost of preference and equity shares since the interest payment on debentures is tax deductible.

2) The investors gets fixed and regular interest irrespective of whether company earns profit or not.

3) Issue of debentures are appropriate when earnings are stable.

4) It is the cheapest method of raising finance and also lower rate of interest makes more economical.

Cons:

1) Ordinary debentures does not enjoy any voting rights it does not take part in the management of the company.

2) Interest on debentures is cumulative. It is paid irrespective of profit or not . In case of losses, it becomes heavy burden to the company.

3) Company will have borrowing capacity. With debentures the borrowing capacity of debentures decreases.

Pros and cons of bonds:

Pros:

1) Interest paid by a bond exceed the interest paid by a bank on savings account.

2) Lendor will receive fixed amount of Interest from bonds.

3) Bonds are less risky, investors who are less tolerance for risk can invest in bonds.

4) Bonds are liquid, it is easy for institution to large quantity of bonds without affecting the prices.

Cons:

1) If the company goes for bankruptcy then the value of the bond reduces.

2) Disadvantages of bonds include rising interest rates,market volatility and credit risk.Bonds prices rise when interest rates fall and viceversa.

3) Bonds are subject to risks such as prepayment risk,interest rate risk, credit risk,liquidity risk and reinvestment risk