Financial Accounting and Reporting-CPA Practice Exam

What is a debenture?

1. A bond secured by specific assets

2. An unsecured bond

3. A type of convertible bond

4. An interest-only bond

The correct answer is: An unsecured bond

A debenture is fundamentally defined as an unsecured bond, which means that it is not backed by any specific assets or collateral. Instead, the repayment of a debenture relies solely on the creditworthiness and financial stability of the issuer. This characteristic distinguishes debentures from secured bonds that are protected by specific assets, ensuring bondholders have a claim to those assets in the event of default. In practice, debentures typically come with a fixed interest rate and a maturity date, offering investors a regular income stream while exposing them to higher risk compared to secured bonds. In the case of a default, debenture holders would stand behind secured creditors in the line for repayment, which can elevate the risks associated with investing in them. The other options refer to different types of financial instruments. For instance, secured bonds possess specific assets backing the investment, providing security to bondholders. Convertible bonds allow investors to convert their bonds into shares of the issuing company at predetermined terms, which adds a potential equity upside. Interest-only bonds have specific payment structures where only interest is paid for certain periods before principal repayment starts. Thus, the unique feature of a debenture as being unsecured makes the chosen answer the correct one, highlighting its distinct role in the landscape of debt financing.