Paralegal Advanced Competency Exam (PACE) Practice Exam

What ensures that debenture holders are prioritized for payment?

1. Specific property liens backing the bond

2. The general credit of the issuer

3. The business’s ongoing profitability

4. The presence of secured assets in the market

The correct answer is: The general credit of the issuer

The prioritization of debenture holders for payment is primarily ensured by the general creditworthiness of the issuer. Debentures are a type of debt instrument that is not secured by physical assets or collateral but rather backed by the issuer's promise to repay the borrowed amount, along with interest, based on its overall credit strength. When investors evaluate debenture investments, they consider the issuer's ability to meet its financial obligations, which typically includes looking at the issuer’s credit ratings, financial stability, and operational track record. If a company has strong creditworthiness, it implies that it is likely to generate sufficient cash flow to honor its debts, including payments to debenture holders. While specific property liens and secured assets can provide forms of security for other types of bonds or loans, debentures rely on the issuer’s credit profile rather than specific collateral backing. Thus, it is the overall financial health and credit standing of the issuer that ultimately ensures that debenture holders are prioritized in the context of repayment during events such as liquidation or restructuring, despite the lack of direct security.