What are debt securities: an explanation in plain language
Hello dear readers!
It so happened that in a society far from the investment market, the word “debt” is stubbornly associated with something negative: there are holes, obligations, receipts in debt. And also — securities, and that's a completely different story. Today I will tell you about what debt securities are, where to buy them, and most importantly, how to make money on them.
- What is it and why are they needed
- Types of debt securities
- Differences between all these types
- Is it profitable for the issuer to borrow with the help of debt securities ?
- What is more profitable for the investor
What is it and why are they needed
The purpose of debt securities is easiest to explain by drawing an analogy with bank lending: the lender gives the borrower funds, and over time receives back the entire loan amount and interest on top of it. The provision of such services must be licensed, and the loan agreement provides a money-back guarantee.
Many companies interested in raising outside capital prefer to borrow from private investors instead of loans. In this case, the guarantor of the fulfillment of financial obligations will be a valuable debt security: a bond, a bill of exchange, a savings certificate, etc. As a result, the issuer (borrower) receives money on credit at a low interest rate compared to bank interest, and the depositor receives a guaranteed profit.
Where are debt securities traded and how are they issued ?
The range of use of debt securities is very wide: you can make good money on buying, selling, pledging and successfully investing them. The turnover takes place on the stock exchanges and markets of the Central Bank. Here, another link appears between the investor and the issuer — an intermediary (broker), who helps to make mutually beneficial transactions for a fee.
Debt securities are issued by issuers in need of investment: private and state-owned enterprises, the state itself. The issue is preliminary coordinated with the Central Bank: if permission is received, the production of forms begins. Further, the offer to sell is placed on the stock market.
Role in the country's economy
The economic situation in the state largely depends on the turnover of securities. This form of investment restrains the growth of inflation, because capital is attracted without additional money supply entering circulation. Through the sale of debt obligations, financing of national projects is provided.
What is the difference between debt and equity securities
Securities that earn interest on the profits of the company that issued them are called equity securities. The simplest example is shares, the owner of which not only receives dividends, but can also participate in shareholder meetings.
Upon liquidation of the enterprise, the shareholder will receive part of its property. The income of the shareholder may exceed the initial expenses many times over, but in the absence of profit, the investor will simply lose money.
Debt securities eliminate the risk of the investor by pre-determining the repayment period and the amount of profit. They are not so liquid and profitable, but they do not require financial intuition or a strict analysis of the situation on the stock market.
Types of debt securities
The difference between debt securities is based on who has the right to issue one or another type, on the timing of their placement, the possibility of transfer to third parties and other features.
These are debt securities for which the issuer undertakes to pay the buyer their face value and a certain percentage before a strictly agreed date. Depending on the maturity, they are:
- short-term (up to 5 years);
- medium-term (5–15 years);
- long-term (from 15 years).
What are the benefits of bonds
It is beneficial for the borrower to issue bonds because the interest rate on them is usually much lower than the lending rate of any bank. The second plus is the preservation of equity, since the right to part of the company's assets is not transferred to the buyer. In addition, a bond loan for a long time is easier to obtain than a loan for the same period.
The bond gives its owner the first right to reimbursement in the event of the issuer's bankruptcy. It can be sold by an investor at a price different from the face value, and then the extra charge will become his income.
Types of bonds
According to the type of payments, they are divided into zero-coupon and coupon (the coupon here is the interest rate). The first ones imply making a profit strictly after the redemption. The second ones provide for interest payments and can be:
- Permanent. All payment rates are fixed.
- Variables. The percentage of income is floating.
- indexed. There is no clear schedule of payments, their amounts depend on inflation.
Most buyers consider permanent coupon bonds more reliable, but, understanding the investment nuances, you can make good money on any of the types.
bill of exchange
It is a variant of a receipt obliging the debtor to pay a certain amount to the bearer of the document before the designated date.
This type of security requires filling out strictly in accordance with the approved form; at the slightest discrepancy, the debt obligation is declared invalid. A promissory note is an independent settlement instrument, it can be paid off. Payments under it are unconditional and are collected regardless of any additional conditions.
Types of bill
Simple — a direct obligation of the borrower to the lender, guaranteeing the return of funds. A transferable one makes it possible to declare a third party a debtor with his consent, for which a promissory note certification procedure is carried out — acceptance. When the paper passes, an endorsement is made on its reverse side — an endorsement.
There is another gradation scheme based on the probability of loan repayment:
- a bill of exchange provides payment for goods and services;
- financial received in exchange for money;
- friendly is issued as a fixation of voluntary assistance to the enterprise;
- bronze is used by scammers who indicated fictitious characters as participants in the transaction.
Debt securities issued exclusively by the state. Their owner receives payments during the entire period of the document, and at the end of it, the amount invested initially is returned. Obligations help replenish the state budget in a short time and are issued for a period of 1 to 10 years.
These are debt securities confirming in writing the bank's obligations to an individual to pay savings deposits, interest on deposit accounts. There are nominal and bearer. The first includes documents with the registered data of the depositor, the second — certificates of free circulation, which can be sold or transferred by proxy to a third party.
Differences between all these types
For clarity, I have collected all the characteristics of debt securities in one table.
|Bond||bill of exchange||treasury bill||savings certificate|
|Release form||Electronic, paper||Paper||Electronic||Paper|
|Who issues||Private and public companies||Company or individual||State||Bank|
|Pay percent||Fixed or floating interest, periodic payments||Fixed amount, one time||The entire period of validity||At the time of return of capital, a fixed interest is paid|
|Maturity||Up to 15 years||By individual agreement||Up to 10 years||Up to 3 years|
|Can it be transferred to a third party||+||+||_||Bearer certificate only|
Is it profitable for the issuer to borrow with the help of debt securities ?
Attracting investments by issuing debt securities is always more profitable for an issuer than obtaining a bank loan or mortgage. In addition to the reduced interest rate, the emission provides several other advantages:
- The ability to use capital for a long period.
- The injection of a large amount of funds into the company's budget.
- Lack of material support.
- Building a positive financial reputation.
What is more profitable for the investor
What are the best debt securities to invest in? The answer to this question depends on the nuances of the particular situation. Traditionally, the most reliable debt securities include bonds, which have two more advantages: active circulation on the stock exchange, the likelihood of a good income.
Treasury certificates inspire confidence in that the government serves as the borrower. Such a security guarantees the return of invested money and timely receipt of interest payments. But, as a rule, they are issued for very large sums and are used to regulate the financial relations of the state and enterprises of national importance.
Savings certificates are not subject to insurance — this trifle, often left unnoticed, can cause the loss of investments in the event of a bank failure.
The promissory note is valuable for its independence from conditions: the borrower will repay it in any case. But history knows a lot of examples when, with the disappearance of a debt document, all agreements were annulled. In addition, it is easier to include a bill of exchange in a fraudulent scheme than any other security.
Each person decides for himself how to deal with his money — whether to invest in stocks or bonds, put it in a savings account or keep it at home in a three-liter jar. All options have a number of benefits and risks.
Therefore, you need to proceed from the goals pursued and an objective assessment of your financial literacy — perhaps my article will help to slightly increase its level. If the text was useful to you, do not forget to like and repost.