6 Types Of Debt Instruments

Introduction

 

On many occasions, we come across situations where we need to make a big investment or make an expensive purchase. Sometimes, our personal funds may not be able to fulfill that need immediately. What do we do on such occasions? 

 

We may take out loans, use credit cards or bonds to carry out these investments. One thing is common to all of these - they all are different types of debt instruments. 

 

‘Debt’ is a term we use to denote money that is owed or due. Likewise, a debt instrument is a mechanism that a company, individual, or government entity can use to raise money. In this blog, we will learn about the various types of debt instruments that are available in the industry at the moment. 

 

What is a debt instrument? 

 

A debt instrument is any form of arrangement that is essentially categorized as debt. Debt instruments give money to a company that pledges to pay it back over time. 

 

Debt is a legal responsibility on the side of the issuer (or taker) to return the lender the borrowed amount plus interest on a timely basis. A debt instrument can be printed or stored electronically. Debt instruments include bonds, debentures, leases, certificates, bills of exchange, and promissory notes.

 

These debt instruments also allow market players to shift debt liability ownership from one person to another. Throughout the life of the instrument, the lender receives a specified amount of money as a form of interest.

 

Also Read | What are Money Market Funds?

 

 

Types of Debt Instruments

 

Different forms of debt instruments may include credit cards, credit lines, loans, and bonds. Principal dealers, banks, and financial institutions have been allowed to trade in debt instruments by the Reserve Bank of India. 

 

It also has a purchase price, which is a fixed rate of return. Currently, a store investor receives a set income. They have also started to show an interest in debt instruments, particularly federal assets.

 

In the points below, we have discussed some important examples or types of debt instruments. 

 

1.  Bonds

 

The term bond suggests that someone owes money to another person.  In these, an investor puts money into corporate or government assets in exchange for a fixed rate of return. If a firm wants to expand its operations, it might procure money from private investors.

 

Corporate bonds are a sort of financial security that a company may use to raise money from the general public. Individual people with brokerage access may be prepared to invest in corporate bond approval as well. Companies, governments, municipalities, states, etc. can use bonds. 

 

Organizational mutual fund investors are strategically among the most significant corporate bond investors, but individuals with brokerage access may have the opportunity to invest in corporate bond issuance as well. Individual and institutional investors use the dynamic secondary market for corporate bonds.

 

Also Read | What is a Mutual Fund?

 

2.  Debentures

 

Debentures are not secured in any way. The organization issues these in order to raise medium and long-term capital. They are components of the capital structure of the firm. Debentures appear on the balance sheet, but they are not included in the share capital.

 

In order to raise finances, the government and major corporations issue long-term debt instruments. The benefit of debentures to the issuer is that they hardly create any type of claim on the assets, leaving them available for future funding. Debentures are normally transferrable by the holder of the debenture. Debenture holders are unable to vote.

 

 

3.  Fixed deposits

 

A fixed deposit is a financial product offered by banks or Non-Banking Financial Corporations that pays a higher rate of interest to investors than a typical savings account.

 

When an account holder makes a fixed deposit, the amount of profit or interest earned on the investment is predetermined. Irrespective of changes in interest rates, the rate will not grow or reduce at any moment.

 

Fixed deposits can range from one week to ten years in length. Fixed deposits cannot be cashed before their expiration date. To put it another way, money cannot be withdrawn for any reason until the deposit's time limit has passed. The bank may levy an early withdrawal penalty or fee if the money is withdrawn too soon.

 

Also Read |  Liquid Funds: Working and Benefits

 

4. Certificates of Deposit

 

A specific time deposit is a CD(certificates of deposit). Banks, thrift institutions, and community banks all provide these debt instruments to customers. Certificates of Deposit are equivalent to conventional bank savings accounts. 

 

They are covered by insurance and are nearly risk-free. CDs differ from savings accounts in that they have a set term (typically 3 months, 6 months, or 1 to 5 years) and, in most cases, a fixed interest rate. CDs can be issued for a duration of not less than one year and not more than three years from the date of release.

 

All-India Financial Institutions and Scheduled Commercial Banks can both issue bonds. CDs issued by banks shall have a maturity duration of no less than 7 days and no more than one year. 

 

5. Commercial Papers (CP)

 

Commercial paper, often known as CP, is a short-term financial instrument used by businesses to raise capital over a one-year period. It is an unprotected form of debt instrument that is issued as a promissory note and was first launched in India in 1990.

 

CPs have a seven-day minimum maturity period of time and a maximum maturity period of one year from the date of issue. The maturity date of the debt instrument, on the other hand, should normally not exceed the date up to which the borrower's credit rating is applicable. They are available in amounts of Rs 5 lakh or multiples of that value.

 

Also Read | Ultra-short Bond Fund- Everything You Need to Know

 

6.  Mortgage

 

A mortgage is a loan secured by a piece of real estate. These debt instruments are used to fund the acquisition of real estates, such as a plot of land, a house, or a commercial building. Mortgages are annualized over time, allowing the borrower to make payments until the debt is paid off. Lenders are paid interest during the life of the loan. 

 

Since a mortgage is backed by a piece of real estate, if the borrower defaults on payments, the asset can be seized and sold to recoup the loaned funds.

 

Also Read | All About Debt Funds

 

Benefits of debt instruments

 

1. Debt instruments offer stable and greater yields than bank fixed deposits, providing them an advantage. 

 

2. Debt instruments can be either long-term or short-term in length. Short-term debt instruments generate revenue that must be returned within a year.Long-term debt instruments, on the other hand, are those that are payable over a period of a year or more. 

 

3. Short-term debt instruments include credit card bills and Treasury notes, whilst long-term debt instruments include long-term loans and mortgages. Interest rate adjustments have a greater impact on the value of long-term debts.

 

4. Debt instruments can be issued by the government, municipalities, a variety of institutions, and enterprises and are extremely crucial for raising capital. The debt market is responsible for capitalizing and mobilizing cash in the economy. 

 

5. Debt instruments market provides a venue for the government, businesses, and other organizations to generate funding. Raising stock can be expensive for a company at times.

 

Also Read |  What is Cash Flow Analysis?

 

 

Conclusion

 

Now the question arises, in India, how secure are these debt instruments? The answer is simple. Debt funds invest in fixed-income assets. It is less risky than equity funds, which invest in equities and are vulnerable to stock market volatility. Debt instruments can help you broaden your portfolio and all in all, make it more impressive.