What Is an Indenture?

Indenture refers to a legal and binding agreement, contract, or document between two or
more parties. Traditionally, these documents featured indented sides or perforated edges.
Historically, indenture has also referred to a contract binding one person to work for
another for a set period of time (indentured servant), particularly European immigrants.
In modern-day finance, the word indenture most commonly appears in bond agreements,
real estate deals, and some aspects of bankruptcies.

There can be several types of indentures, all typically involved with debt agreements, real
estate, or bankruptcy.
Types of Indentures
Below are some of the common types of indentures and clauses that may be associated with
indenture contracts.

Real Estate Indenture

In real estate, an indenture is a deed in which two parties agree to continuing obligations.
For example, one party may agree to maintain a property and the other may agree to make
payments on it.
Bankruptcy Indenture
In bankruptcy law, an indenture may be referenced as proof of a claim on property.
Indentures in general provide details on collateralized property, constituting the claim a
lender has against a debtor, usually secured with a lien on the debtor's property.
Credit Indentures
A credit indenture is the underlying contract agreement that details all of the provisions
and clauses associated with a credit offering. In non-secure, uncollateralized bond
offerings, these indentures can also be called debentures.
Typically a credit indenture is used for the sake of bond issuers and bondholders. It
specifies the important features of a bond, such as its maturity date, the timing of interest
payments, method of interest calculation, callability, and convertible features, if applicable.
A bond indenture also contains all the terms and conditions applicable to the bond issue.
Other critical information included in the indenture are the financial covenants that govern
the issuer and the formulas for calculating whether the issuer is within the covenants
(usually ratios based on corporate financials). Should a conflict arise between the issuer
and bondholder, the indenture is the reference document utilized for conflict resolution.
In the fixed-income market, an indenture is hardly ever referred to when times are normal.
But the indenture becomes the go-to document when certain events take place, such as if
the issuer is in danger of violating a bond covenant. The indenture is then scrutinized
closely to make sure there is no ambiguity in calculating the financial ratios that determine
whether the issuer is abiding by the covenants.

Other Common Credit Indenture Terms

In a credit offering, a closed-end indenture clause may be used to detail any collateral
involved that provides backing for the offering. Closed-end indentures include collateral as
well as provisions that ensure the collateral may only be assigned to one specific offering.
Other terms that may also be associated with credit indenture clauses can include open-end
indenture, subordinated, callable, convertible, and non-convertible.
In some credit indentures, a trustee may be hired by a bond issuer. When a trustee is
involved, a trust indenture will also be needed. A trust indenture is similar to a bond
indenture, except it also details the trustee’s responsibilities in overseeing all of a bond
issue’s terms.
An indenture trustee handles fiduciary duties related to credit issuance. These
professionals monitor interest payments, redemptions, and investor communications. They
may also lead trust departments at institutions. Essentially, their role is to oversee and
administer all of the terms, clauses, and covenants of an indenture issued by a company or
government agency.

https://www.investopedia.com/terms/i/indenture.asp

What Is a Debenture?
A debenture is a type of bond or other debt instrument that is unsecured by collateral. Since
debentures have no collateral backing, they must rely on the creditworthiness and reputation of
the issuer for support. Both corporations and governments frequently issue debentures to raise
capital or funds.
Debentures
Debentures are bonds that are not secured by a specific asset. Unsecured debt with original
maturities of 10 years or less are referred to as notes, while unsecured debt with original
maturities greater than 10 years are referred to as debentures. Both are often referred to as
debentures.

Debentures
Debenture holders are general creditors.
When corporations issue a number of debentures, some may be issued that are subordinate to
others (in terms of their claim on assets in the case of bankruptcy) -- subordinate debentures.
Debenture are often issued with protective covenants: restrictions on additional debt, etc.
Debenture could be sold with credit enhancements (e.g., letter of credit from a third party).

Understanding Debentures
Similar to most bonds, debentures may pay periodic interest payments called coupon payments.
Like other types of bonds, debentures are documented in an indenture. An indenture is a legal
and binding contract between bond issuers and bondholders. The contract specifies features of a
debt offering, such as the maturity date, the timing of interest or coupon payments, the method of
interest calculation, and other features. Corporations and governments can issue debentures.
Governments typically issue long-term bonds—those with maturities of longer than 10 years.
Considered low-risk investments, these government bonds have the backing of the government
issuer.
Corporations also use debentures as long-term loans. However, the debentures of corporations
are unsecured. Instead, they have the backing of only the financial viability and creditworthiness
of the underlying company. These debt instruments pay an interest rate and are redeemable or
repayable on a fixed date. A company typically makes these scheduled debt interest payments
before they pay stock dividends to shareholders. Debentures are advantageous for companies
since they carry lower interest rates and longer repayment dates as compared to other types of
loans and debt instruments.
Types of Debentures
Registered vs. Bearer
When debts are issued as debentures, they may be registered to the issuer. In this case, the
transfer or trading in these securities must be organized through a clearing facility that alerts the
issuer to changes in ownership so that they can pay interest to the correct bondholder. A bearer
debenture, in contrast, is not registered with the issuer. The owner (bearer) of the debenture is
entitled to interest simply by holding the bond.
Redeemable vs. Irredeemable
Redeemable debentures clearly spell out the exact terms and date by which the issuer of the bond
must repay their debt in full. Irredeemable (non-redeemable) debentures, on the other hand, do
not hold the issuer liable to repay in full by a certain date. Because of this, irredeemable
debentures are also known as perpetual debentures.
Convertible vs. Nonconvertible
Convertible debentures are bonds that can convert into equity shares of the issuing corporation
after a specific period. Convertible debentures are hybrid financial products with the benefits of
both debt and equity. Companies use debentures as fixed-rate loans and pay fixed interest
payments. However, the holders of the debenture have the option of holding the loan until
maturity and receive the interest payments, or convert the loan into equity shares.
Convertible debentures are attractive to investors that want to convert to equity if they believe
the company's stock will rise in the long term. However, the ability to convert to equity comes at
a price since convertible debentures pay a lower interest rate compared to other fixed-rate
investments.
Nonconvertible debentures are traditional debentures that cannot be converted into equity of the
issuing corporation. To compensate for the lack of convertibility investors are rewarded with a
higher interest rate when compared to convertible debentures.

Features of a Debenture
When issuing a debenture, first a trust indenture must be drafted. The first trust is an agreement
between the issuing corporation and the trustee that manages the interest of the investors.
Interest Rate
The coupon rate is determined, which is the rate of interest that the company will pay the
debenture holder or investor. This coupon rate can be either fixed or floating. A floating rate
might be tied to a benchmark such as the yield of the 10-year Treasury bond and will change as
the benchmark changes.
Credit Rating
The company's credit rating and ultimately the debenture's credit rating impacts the interest rate
that investors will receive. Credit-rating agencies measure the creditworthiness of corporate and
government issues.2 These entities provide investors with an overview of the risks involved in
investing in debt.
Credit rating agencies, such as Standard and Poor's, typically assign letter grades indicating the
underlying creditworthiness. The Standard & Poor’s system uses a scale that ranges from AAA
for excellent rating to the lowest rating of C and D. Any debt instrument receiving a rating lower
than a BB is said to be of speculative grade.3 You may also hear these called junk bonds. It boils
down to the underlying issuer being more likely to default on the debt.
Maturity Date
For nonconvertible debentures, mentioned above, the date of maturity is also an important
feature. This date dictates when the company must pay back the debenture holders. The company
has options on the form the repayment will take. Most often, it is as redemption from the capital,
where the issuer pays a lump sum amount on the maturity of the debt. Alternatively, the payment
may use a redemption reserve, where the company pays specific amounts each year until full
repayment at the date of maturity.
Pros and Cons of Debentures
Debentures are the most common form of long-term debt instruments issued by corporations. A
company will issue these to raise capital for its growth and operations, and investors can enjoy
regular interest payments that are relatively safer investments than a company's equity shares of
stock.
Debentures are unsecured bonds issued by corporations to raise debt capital. Because they are
not backed by any form of collateral, they are inherently more risky than an otherwise identical
note that is secured. Because of the increased risk, debentures will carry a comparatively higher
interest rate in order to compensate bondholders. This also means that bond investors should pay
careful attention to the creditworthiness of debenture issuers.
The relative lack of security does not necessarily mean that a debenture is riskier than any other
bond. Strictly speaking, a U.S. Treasury bond and a U.S. Treasury bill are both debentures. They
are not secured by collateral, yet they are considered risk-free.
Pros
 A debenture pays a regular interest rate or coupon rate return to investors.
 Convertible debentures can be converted to equity shares after a specified period, making
them more appealing to investors.
 In the event of a corporation's bankruptcy, the debenture is paid before common stock
shareholders.
Cons
 Fixed-rate debentures may have interest rate risk exposure in environments where the
market interest rate is rising.
 Creditworthiness is important when considering the chance of default risk from the
underlying issuer's financial viability.
 Debentures may have inflationary risk if the coupon paid does not keep up with the rate
of inflation.

Is a Debenture an Asset or a Liability?

This depends on whose perspective is considered. As a debt instrument, a debenture is a liability
for the issuer, who is essentially borrowing money via issuing these securities. For an investor
(bondholder), owning a debenture is an asset.
The Bottom Line
Debentures are a common form of unsecured bonds issued by corporations and governments. In
contrast to secured bonds, which are backed by collateral, unsecured bonds are relatively riskier
since they do not offer any sort of backstop of assets if the issuer defaults: they rely solely on the
creditworthiness of the issuer. Strictly speaking, a U.S. Treasury bonds are, in this way,
debentures.

Debenture Risks to Investors

Debenture holders may face inflationary risk.4 Here, the risk is that the debt's interest rate
paid may not keep up with the rate of inflation. Inflation measures economy-based price
increases. As an example, say inflation causes prices to increase by 3%. Should the
debenture coupon pay at 2%, the holders may see a net loss, in real terms.
Debentures also carry interest rate risk.4 In this risk scenario, investors hold fixed-rate
debts during times of rising market interest rates. These investors may find their debt
returning less than what is available from other investments paying the current, higher,
market rate. If this happens, the debenture holder earns a lower yield in comparison.
Further, debentures may carry credit risk and default risk.5
 As stated earlier, debentures are only as secure as the underlying issuer's financial
strength. If the company struggles financially due to internal or macroeconomic factors,
investors are at risk of default on the debenture. As some consolation, a debenture holder
would be repaid before common stock shareholders in the event of bankruptcy.

How Is a Debenture Different From a Bond?

A debenture is a type of bond. In particular, it is an unsecured or non-collateralized debt
issued by a firm or other entity and usually refers to such bonds with longer
maturities. Secured bonds are backed by some sort of collateral in the form of property,
securities, or other assets that can be seized to repay creditors in the event of a
default. Unsecured debentures have no such collateralization, making them relatively
riskier.

https://www.investopedia.com/terms/d/debenture.asp