Debentures vs. Subordinated Debentures: Understanding the Differences

A debenture is a type of bond that does not use collateral. It's otherwise recognized as any unsecured long-term debt. Because the bonds are unsecured, it's imperative for the issue to be profitable for the corporation. Because of its lack of collateral this makes the bond more risky. This risk means the bond should pay a higher interest rate in order to compensate for the risk. The greater the risk the greater the interest rate should be because the issue does not have collateral to pay in case the corporation is not profitable.

A subordinated debenture is similar in character however in this case they are payed as a subordinate issue. This leaves the subordinate debenture acting as a junior debt to the more senior debenture in case of insolvency. As you might imagine these issues, although linked to the debentures, pay a higher interest rate.

In the case that the corporation does become insolvent, the more subordinated a note is the more risky it would be. Imagine a series of issues with senior debt and junior debt this flow of funds from the corporation to the bond investors happens like a funnel.