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Unsecured debentures are debt instruments issued by companies by which investors provide capital for expansions or significant expenditures in exchange for a certificate acknowledging the debt and a contractual agreement to repay the principal at a set time with a preset interest rate. By definition, unsecured debentures do not have any company assets, income streams, or holdings applied to them as collateral against the loans. In the event of default, the holders of unsecured debentures have the same standing as other unsecured creditors of the issuing company. In most cases, however, companies offer a commitment to debenture investors that the company will not secure other loan arrangements with its assets ahead of the debenture issue, which would otherwise make repayment of the debentures subordinate to repayment of the secured loans. Government bonds, issued under the seal of the nation issuer, represent unsecured debentures, since no government properties or assets guarantee repayment of the bonds.
Although companies raise capital by issuing both debentures and stock shares, there are distinct differences between the two forms of investment. Investors who purchase stock have equity in the company and have the right to attend shareholders' meetings and vote on company affairs. Debenture holders provide loan capital to the company as creditors and, as such, do not have equity in the company. Unsecured debentures do not impart any right to control the affairs of the issuing company. Furthermore, the company pays variable-rate dividends to shareholders only when the company has profit, whereas debenture holders receive compulsory fixed rate repayments regardless of the profits or losses of the company.
Some unsecured debentures are convertible into equity on given dates or within specified periods. Companies may offer partly convertible debentures, in which a portion of the debt converts into shares over time while the company redeems the rest by another means. In general, investors may opt to convert fully convertible debentures, in which the company may redeem the entire balance due in company shares, between 18 and 36 months of the allotment date. The convertibility features of some corporate bonds allow the issuing companies to offer lower interest rates for those debentures than for non-convertible debentures.
The coupon rate or rate of interest for a debenture can be either floating or fixed. Floating rates link to the government treasury bond rates or bank rates with an added premium to compensate investors for risk. Fixed rate debentures, which do not fluctuate with bank rates, are paid at preset intervals, usually every six months. Zero coupon debentures do not have specified interest rates, but the issuing companies compensate investors by selling the bonds at significant discounts relative to the maturity value.