Non secured corporate bonds offer higher rates of return than secured bonds. When a bond is secured, it is backed by collateral. That collateral could be" cash, securities, real estate or equipment.

Debentures are rated for credit quality so that investors can make an informed decision. The lower the rating, the higher the yield or rate of return. "Higher risk equals higher yield". That is true for all investments and certainly includes bond investments. The 2 primary rating companies are Standard and Poors (S & P) and Moodys. Based on their ratings, debentures will be priced to sell at the minimum yield it will take for investors to buy them.

Their rating system breaks down as such:

S&P
AAA - The highest rating a debenture can receive.
AA
A
BBB

BBB and higher is considered investment grade. Investment grade bonds are normally a good risk and default is remote. Investors looking to protect their capital with debenture bonds should only invest in investment grade issues.

Speculative or "junk bonds" are rated below beginning with BB.

BB
B
CCC
and so on...

Moodys has a similar rating system for debentures. They use some lower case ratings to set themselves apart from S&P.

Moodys

(Investment Grade)
Aaa
Aa
A
Baa

(Speculative)

Ba
B
Caa

If a corporation fails to make interest payments or does not return the par value principal at maturity on debentures, the company would be in default. If the company goes out of business, they still owe the money to the investors. Debentures are paid after other obligations and secured debt is paid. In the event of a liquidation, they are paid ahead of stockholders but not above other secured bondholders.

Debentures always have a rate above U.S. Treasuries on the same maturity. U.S Treasury bonds are the safest bonds issues, so for corporate issues to be sold, they must offer an attractive spread over treasuries.

Debentures are fully taxable. Any interest earned is taxed federal, state and local. Since they are fully taxable, their coupon rates are higher.

Subordinated debentures are the same as debentures in most ways. They are backed by the full faith and credit of the company. However, subordinated debentures pay a high rate, but have a lower priority if the company goes out of business. Subordinated issues are the last bonds to be paid. They are the last creditors, before stockholders to be paid. Not all companies offer subordinated debentures. The risk is obvious, but if the company does not liquidate, the investors will benefit because of the higher rate of return. Their rating is normally lower when compared to similar debenture issues.

Corporate bonds can be callable by the issuer. Call dates can be placed on the bond and this allows the company to redeem the bonds early beginning on set dates and at set redemption prices. This is normally not a good feature for investors, because an issue is normally called when interest rates are low - lower than your coupon rate. The main reason debentures or bonds in general are called, is because the issuer wants to refinance their debt at a lower rate. When this happens, the investor is faced with having his money (par) returned early, but the higher paying bond is no more. To make matters worse, interest rates are lower in the market, so finding a suitable replacement will be difficult, if not impossible. Callable bonds to pay a higher yield though, so for some the risk is worth it.

Corporate debentures have a place in every bond portfolio.

More on Debentures.