Refresh April 20, 2025 9:52 AM ET
Unsecured Bonds
from InvestmentCare.com
Debentures Debentures are unsecured bonds that are not backed by any pledged asset, but are secured only by the faith and credit of the corporation. In this case, debenture holders act as general creditors whose claim to certain assets are against property that has not been previously pledged. The use of debentures will usually depend on the size and type of the corporation as well as its credit strength.
For example, a large, well-established company will use debentures because there is simply no need to pledge assets for its debt. However, smaller less stable companies that may have already pledged most of their assets also use debentures. In this case, small companies with more associated risk will usually render a higher interest rate. In the event of a default, debenture holders typically maintain a position behind secured bondholders but before stockholders in the claim on corporate assets.
Subordinated Debentures
Subordinated debentures are unsecured bonds that have a subordinated position, or junior claim, against corporate assets. In the event of a bankruptcy, liquidation, or other situation that may require payment to its bondholders, subordinated debenture holders will receive payment only after senior debt has been paid and as described by the debentures? indenture. Subordinated debentures can be in the form of designated notes payable, as in bank loans, or other debt.
Convertible Debentures
Convertible debentures allow debenture holders the right to convert their bonds into the common stock of the issuer corporation. How a debenture is converted into a stock depends on certain conversion features. Conversion features consist of a conversion price, which is established at the point of issuance and determines the number of shares of common stock a debenture holder will receive upon conversion, and a conversion ratio, which is the actual number of shares received.
Conversion features may also change in the event of a stock split or stock dividend. For stock splits, the conversion ratio would change by adjusting the conversion price of the stock with the corresponding split. Additionally, for stock dividends, the conversion ratio would increase by the corresponding percentage dividend.
One of the advantages to issuing convertible bonds over non-convertible bonds is that issuing corporations can borrow funds at a lower interest rate. For bondholders, the benefits of preferred placement for liquidation rights, and the flexibility of conversion in the event of a stock price increase, is greater than the receipt of a lower interest rate. Conversely, some of the disadvantages to convertible bonds are the possibility of earnings dilution in the event that all convertible bonds are converted at one time, and the possible tax implications on pre-tax earnings distributions.
Parity
The existence of convertible debentures also allows for the dual presence of both bonds and common stock. One of the important factors in the existence of two different securities is determining the conversion ratio from bonds to stocks. In this process, it becomes important that a comparison is made between the market value of the bond and the market value of the stock.
Parity occurs when the value of the bond is equal to the market value of the common stock at its converted price. Usually, convertible bonds will have a market price that is greater than the parity price. In other words, parity is used to see the price at which a stock must be selling to equal the value of a bond at a specified price. Please see the calculation on the Parity Price of Stock for further details.
