Debt Securities Analyzed
Debt securities are financial instruments that entitle their holder to the payment of principal and interest. The buyer of the security lends the issuer money in exchange for the security. The buyer then receives interest payments at a rate described in the security and, at maturity of the security, the principal. These securities are transferable, which means that the buyer or holder can, at his or her discretion, sell the securities to someone else, who in turn gains the rights to receive interest payments (at pre-agreed intervals) and the principal (when the security matures) from the issuer. Debt securities are among the safest and most liquid securities because their riskiness is determined by the creditworthiness of the issuer. But on the other hand, higher risks of payment usually lead to higher interest rates, so the choice of security to invest in mostly depends on the investor’s attitude towards risk.
There are many different debt securities, depending on the issuer, term of maturity, collateral land other characteristics. Main types of debt securities include bonds, banknotes and debentures.
Bonds are debt securities that entitle the holder to payments of interest and principal from the issuer. They are similar to loans, in the sense that there is a borrower (debtor) that issues the bond, the holder (creditor) that buys the bond and then lends money to the borrower and a coupon which is the interest. The borrower basically breaks down, what would in other cases be, a large loan into many smaller pieces which are represented by bonds. This enables him/her to borrow money from a large number of investors that otherwise would not be able to lend the desired amount to the lender individually. Issuing bonds is sometimes a preferable method to taking a loan because it is possible to collect far larger amounts of money than through the use of a classic loan. Also, due to the fact that the bank can ask for the repayment of the loan at any time, bonds are more reliable. There are many different types of bonds.
Banknotes are promissory notes made by a bank that are payable to the holder on demand. In the United States, each one represents a certain amount of debt held by the Federal Reserve. In most countries and jurisdictions they represent legal tender and can be traded for goods and services anywhere in that country.
Debenture is a document that creates or acknowledges debt. They are used in corporate finance as a term for medium- and long-term debt instruments that large companies use to borrow money. They are usually freely transferable by the holder. There are two types of debentures: convertible debentures and non-convertible debentures.
Convertible debentures can be converted into equity shares after a predetermined amount of time. Companies that issue debentures often add the convertibility feature to make them more attractive to investors and they usually have lower interest rates than nonconvertible bonds.
Non-convertible debentures (or regular debentures) cannot be converted into equity shares of the issuing company and, as a result, they often carry higher interest rates than the convertible bonds.