Breaking free from conventional investment paths; How to make your money work harder - Part II

Repayment obligations - No immediate repayment obligations in equity financing.

- By SECURITIES AND EXCHANGE COMMISSION OF SRI LANKA

In debt financing however, the borrowed amount must be repaid within a time frame.

Interest payments — In terms of equity financing, there are no interest payments but in debt financing regular interest payments are required.

Debentures Decoded: The Company IOU System

Debentures are essentially formal IOUs that companies give you when you lend them money. What makes them particularly attractive to investors is their predictable nature and security features. They offer fixed returns, meaning you know exactly how much you'll earn or can predict your return with certainty. Most debentures provide regular income through interest payments made every six months, creating a steady cash flow for investors. Each debenture comes with a specific maturity date when the company must repay the full principal amount you originally lent them. Perhaps most importantly, debenture holders enjoy priority treatment in the company's capital structure, which means if the company faces financial difficulties, debenture holders get paid before shareholders, providing an additional layer of security for your investment.

The Flip Side: What Could Go Wrong?

Like any investment, debentures come with risks:

Interest Rate Risk - When interest rates rise, existing bond prices fall since newer bonds offer higher yields. Long-term bonds are more sensitive to rate changes than short-term ones. This creates potential capital losses if you need to sell before maturity.

Credit Risk - The borrower may default on interest payments or fail to repay the principal. This is particularly relevant to corporate bonds, high-yield bonds, and emerging market debt. Even government bonds aren't immune, as sovereign defaults can occur.

Inflation Risk - Fixed-rate debt investments lose purchasing power when inflation exceeds the bond's yield. Your real return (after inflation) may be negative even if you receive all promised payments.