Business Finance · Financial instruments issued or used by companies

Corporate Bonds, Debentures and Loan Stock Explained

Updated 11 October 2026 · Fact-checked

Corporate bonds, debentures and loan stock are loans a company raises from investors. The company pays interest and repays capital on set terms. You answer questions by stating the security (fixed or floating charge), the ranking on liquidation, the covenants and the redemption terms, then linking each to risk and yield.

Understand Corporate Bonds, Debentures and Loan Stock

A company can raise money by borrowing instead of selling shares. When it borrows from many investors at once, it issues bonds, debentures or loan stock. The investor is a creditor, not an owner. The company promises interest (the coupon) and repayment of the nominal value at redemption. If it fails, the lender can take legal action. A shareholder cannot.

The names overlap. In the UK-style usage the IAI syllabus follows, a debenture is usually debt secured by a charge on company assets. Loan stock is often unsecured, so it is a bare promise to pay. Bond is the general word. Always say how you are using each term. Examiners reward you for linking the label to the security.

Security is about what the lender can claim if the company defaults. A fixed charge attaches to a specific asset, such as a building or plant. The company cannot sell that asset without the lender's consent. A floating charge covers a pool of changing assets, such as stock or receivables. The company can trade freely with them until a default event. At that point the charge crystallises and fixes on whatever assets are then in the pool.

Ranking matters on liquidation. Broadly, holders of fixed-charge debt are paid first from the proceeds of the assets charged to them. Then costs and preferential creditors are paid, then floating-charge holders from the floating-charge assets, then unsecured creditors, then preference shareholders, then ordinary shareholders. Preferential creditors rank ahead of floating-charge holders, so the two do not share one tier. Exact priority depends on the law in force, so describe the general order and state that it is general. Lower rank means higher risk, so investors demand a higher yield.

Covenants are promises in the trust deed that protect lenders. Positive covenants require actions, such as providing accounts. Negative covenants restrict actions, such as limiting extra borrowing, asset sales or dividends. A common one is a maximum gearing or a minimum interest cover. Breach lets lenders demand early repayment or renegotiate. Covenants reduce credit risk, so they lower the yield the company must offer.

Redemption features set when capital is repaid. Options include a fixed date, a range of dates at the company's choice, early redemption by the company (a call option), early redemption by the holder (a put option), or repayment in instalments. A sinking fund sets money aside to repay. Bonds may also be convertible or index-linked, which you study separately. Features that favour the company, such as a call option, raise the yield. Features that favour the investor lower it.

Key rules to remember

Order of claims on liquidation (general): Fixed-charge holders (from charged assets) → costs and preferential creditors → floating-charge holders (from floating-charge assets) → unsecured creditors → preference shareholders → ordinary shareholders; A general order only. The exact priority, especially of statutory and preferential claims, depends on the insolvency law in force. State this caveat.
Interest cover: Interest cover = Profit before interest and tax ÷ Interest payable; Covenants often set a minimum. Higher cover means lower default risk.
Gearing (debt-based): Gearing = Debt ÷ (Debt + Equity); Definitions vary. State which one you use. Some use Debt ÷ Equity.
Coupon payment: Annual coupon = Coupon rate × Nominal value; Coupon is set on nominal value, not on market price.
Current yield: Current yield = Annual coupon ÷ Market price; Ignores redemption gain or loss. It is not the redemption yield.

How to solve Corporate Bonds, Debentures and Loan Stock questions

Use this order for any question on company debt. It keeps your answer complete and tied to the question.

1Identify the instrument: bond, debenture or loan stock. State whether it is secured or unsecured.
2State the security. Say whether the charge is fixed or floating and what assets it covers.
3Place the instrument in the ranking on liquidation, with the caveat that statutory claims depend on current law.
4List the relevant covenants, split into positive and negative, and say who they protect.
5State the redemption terms: date, call or put options, sinking fund, instalments.
6Link each feature to risk and required yield. More security and covenants lower yield. More company-friendly options raise it.
7If numbers are given, compute coupon, interest cover or gearing with the formula, showing working and the definition used.
8Finish with a one-line conclusion that answers the exact question asked.

Quickest way: SRCR check: Security, Ranking, Covenants, Redemption

When to use it: Use it for multiple-choice questions and short written parts that ask you to compare or describe debt instruments.

Write S, R, C, R on your paper.
Next to each letter, note the one key fact for the instrument in the question.
Decide the risk direction: more security or covenants means lower risk and lower yield.
Check redemption options: call favours the company, put favours the investor.
Pick the option or write the answer that matches your notes.

Common mistakes in Corporate Bonds, Debentures and Loan Stock

Saying a floating charge stops the company selling the charged assets.
Students mix up fixed and floating charges because both are called security.
Fix: Fixed charge: specific asset, sale needs consent. Floating charge: changing pool, free dealing until crystallisation on default.
Treating debenture holders as owners with voting rights.
The word stock sounds like shares.
Fix: Debt holders are creditors. They get interest and repayment, and normally no vote on company matters.
Stating one exact liquidation order as fixed for all cases.
Notes show a simple ladder and students memorise it as absolute.
Fix: Give the general order and say preferential and statutory claims depend on the law in force.
Calling a call option a benefit to the investor.
The word option sounds like a right for the holder.
Fix: Ask who holds the right. The issuer holds a call. The holder holds a put. Then judge who gains.
Computing coupon on market price.
Price is the number most visible in the question.
Fix: Coupon = rate × nominal value. Use market price only for yield measures.
Listing covenants without saying why they matter.
Students memorise lists to save time.
Fix: After each covenant, add who it protects and how it lowers credit risk.

Worked examples

Example 1

A company issues ₹10,00,00,000 of 8% debentures with nominal value ₹100 each, secured by a fixed charge on its factory. Its profit before interest and tax is ₹30,00,00,000. It has no other debt. (a) Find the annual interest. (b) Find the interest cover. (c) Explain why the fixed charge lowers the yield required.

Show the solution

(a) Interest = 8% × ₹10,00,00,000 = ₹80,00,000.
(b) Interest cover = ₹30,00,00,000 ÷ ₹80,00,000 = 37.5 times.
(c) The fixed charge ties the debt to a specific asset, the factory. If the company defaults, holders can look to the proceeds of that asset for repayment.
This improves the expected recovery, so credit risk is lower.
Investors accept a lower yield for lower risk, so the company can offer a lower coupon than for unsecured loan stock.

Answer: Interest is ₹80,00,000 a year. Interest cover is 37.5 times. The fixed charge improves recovery on default, so investors require a lower yield.

Example 2

Compare unsecured loan stock with debentures secured by a floating charge, covering security, ranking and likely yield. Then name two negative covenants a lender might require.

Show the solution

Security: unsecured loan stock has no charge, so holders have only a contractual claim. Floating-charge debentures are secured over a changing pool of assets, such as stock and receivables, which crystallises on default.
Ranking: floating-charge holders generally rank ahead of unsecured creditors on liquidation, subject to preferential and statutory claims under the law in force. Unsecured loan stock ranks behind them.
Yield: unsecured stock carries higher risk and more loss on default, so investors require a higher yield. Floating-charge debentures need a lower yield.
Negative covenants: (1) a limit on further borrowing or on gearing, which stops new debt diluting the lender's claim. (2) A limit on dividends or asset sales, which stops value leaving the company.
These covenants reduce credit risk, so they also help lower the yield.

Answer: Floating-charge debentures have asset backing, generally rank higher and need a lower yield. Unsecured loan stock ranks lower and needs a higher yield. Two negative covenants are a cap on additional borrowing and a restriction on dividends or asset disposals.

Exam tips

For compare or contrast questions, use the same four headings for each instrument: security, ranking, covenants, redemption.
Always add the yield link. Marks are often given for connecting a feature to risk and return.
State your definition of gearing before calculating. Examiners accept clear, consistent definitions.
In multiple-choice questions, check who holds an option. Call is the issuer's right and put is the holder's.
Keep the liquidation order general and mention that statutory claims depend on current law.

Practice questions from Financial instruments issued or used by companies

Corporate Bonds, Debentures and Loan Stock in other exams

The same ground in other exams, if you are preparing for more than one or want another angle on it.

Corporate Bonds, Debentures and Loan Stock: frequently asked questions

What is the difference between secured and unsecured loan stock?

Secured loan stock has a charge over company assets, so holders have a claim on those assets if the company defaults. Unsecured loan stock has no charge and relies on the company's promise to pay. Unsecured stock ranks lower and needs a higher yield.

What is the difference between a fixed charge and a floating charge?

A fixed charge attaches to a specific asset and the company cannot sell it without consent. A floating charge covers a changing pool of assets, which the company can use in normal trading. On default, the floating charge crystallises and attaches to the assets then held.

How are corporate bonds ranked on liquidation?

In general, fixed-charge holders are paid from the charged assets first. Costs and preferential creditors come next, then floating-charge holders from the floating-charge assets, then unsecured creditors, then preference shareholders, then ordinary shareholders. The exact priority depends on the law in force.

What are bond covenants and how do they affect credit risk?

Covenants are promises in the trust deed that protect lenders. Positive ones require actions such as supplying accounts. Negative ones restrict actions such as extra borrowing or dividends. They lower credit risk, so the company can usually pay a lower yield.