Difference Between Shares, Debentures & Bonds

Shares, debentures and bonds are common options for investment. They all vary significantly in terms of returns and performance. You need to understand how they differ from each other to decide the one most suitable for your portfolio.

Here is a detailed guide outlining the differences between shares, debentures and bonds. 

Debentures, Shares and Bonds: What are the top differences?

The following table illustrates the difference between debentures, bonds, and shares. 

What are the similarities between shares and debentures?

Despite some significant differences between shares and debentures, there are some striking similarities among them. Both shares and debentures are investment options. While they vary significantly in nature from each other, there are some similarities between them: 

• Companies use both to raise funds. 
• Shares and debentures can be public. 
• Both share and debenture holders are company investors. 
• Both options are tradeable on exchanges. 

What are debentures and bonds? (with example)

Debentures are basically medium or long-term instruments that corporate or government companies issue to raise capital. This capital is usually required for long-term, capital-demanding projects. There is usually no collateral, and investors rely on the borrowers’ credit ratings and reputation. Investors earn through interest payments. 

Here is an example to help you understand what is a debenture and how its interest computation works: 

Suppose, a company issued Rs.2,40,000 debentures at a 4% coupon rate (interest rate). The formula for calculating interest payment is – 

Interest Payment = Interest Rate/ 100 * Debt Amount = 4/100*2,40,000 = Rs.9,600 

Bonds are debt instruments issued by borrowers such as corporate or government companies to raise capital. Bonds are known as a fixed-income security, as they pay their holders a fixed sum for a pre-determined period at regular intervals. 

Here is an illustration of how bonds work: 

Suppose, you purchased a bond of Rs.500 with a maturity term of 2 years at a 4% interest (coupon) rate. The company makes semi-annual payments and issued the bonds on 1 March 2022. 

The bondholders will receive payments on 1 September 2022, 1 March 2023, 1 September 2023, and 1 March 2024. 

Hence, the bondholders will receive the following payments on the dates: 

1 September 2022: Rs.500 * (4%/2) = Rs.10 (4%2 for semi-annual payments)

1 March 2023: Rs.500 * (4%/2) = Rs.10

1 September 2023: Rs.500 * (4%/2) = Rs.10

1 March 2024: Rs.500 * (4%/2) + Rs.500 = Rs.510 (last payment includes the principal)

The above-mentioned table shows the differences between bond and debentures. However, there are some similarities between the two, which are discussed below. 

Are debentures a type of bond?

Yes, debentures are a type of bond. Any unsecured bond without any collateral is a debenture. As there are no collaterals, investors investing in debentures primarily rely on the borrower's reputation and creditworthiness as per the credit ratings for assurance. 

Public and private companies frequently issue debentures to raise funds for their needs. In that sense, all bonds cannot be debentures, but all debentures are bonds.  

Why are debentures better than shares?

Shares and debentures both have their share of benefits and drawbacks. Which one can be a better investment option, totally depends upon an investor. 

Shares have better liquidity and the potential to earn a higher return. On the other hand, debentures are considered a safer investment avenue offering an income in the form of interest. 

Notably, a company has to pay interest on the debenture before it can pay dividends to its shareholders. Hence, debenture holders hold an advantage in this one scenario. If a company goes bankrupt, it will surely pay the debenture holders first and then the shareholders. 

Conclusion

Debentures, shares, and bonds are all different avenues for investment. You should choose your option based on your investment goals, risk appetite, and investment horizon.  Determine the investment objective, analyse the risk profile, conduct thorough market research and choose a suitable investment avenue.