Meaning of Debt Market
In the corporate world, there are different activities, projects, or needs for which an entity requires funding. These funds are usually long-term funds that are raised for more than one year. There are various sources through which these funds can be raised. But the most common and usually used source is debt. Debt is a cheaper and simpler way to raise funds, although it carries fixed financial charges in the form of interest.
Usually, in a market, when funds are required by an entity, the entity issues debt, and a lender who is worthy enough to buy it pays for it. This selling and buying of debt securities are called the “debt market.”
What is Debt Market?
Debt market refers to the arrangement where buying and selling of securities take place in the form of bonds or debts. It is a market where an investor or lenders can easily approach each other. In the debt market, different types of bonds are issued at different rates of interest. Usually, the bonds or securities are issued by the government and various corporate entities to the potential lender. These bonds are repaid to the lender after a specified period.
Debt Market Instruments
Debt market instruments are all those securities that are issued by the private sector, the public sector, or the government to raise funds in the market. In this type of security, the rate of interest is fixed and is paid regularly at constant intervals. Debt instruments are the documents that represent the obligations for repayment. According to that document, the money borrowed by the entity should be repaid to the investor.
There are various types of debt market instruments that are available to a user. Some of them are:
Bonds are the most common debt market instruments that are in the form of documents containing information about debt, rates of interest, and repayment periods. It forms a contract between the lender and borrower and binds the borrower with obligations.
Bonds are commonly issued by government entities and individual businesses. Bonds are usually issued at the market price and contain a fixed charge in the form of interest. The rate of interest is called the face value of a bond, and usually, it is always in percentage form.
There are various types of bonds that are issued by different entities, such as government bonds, institutional bonds, corporate bonds, and municipal bonds. It depends on the lender and borrower in which types of the bond they want to deal with.
Debentures are a type of long-term loan that is issued when capital is required for specific or unique projects. Debentures, unlike bonds, also bear a specific rate of interest that is represented in percentage form. However, in debentures, no asset is given as collateral. The trust between the lender and the borrower forms a contract.
Debentures are used by both government and corporate entities to fund various projects. However, the debentures issued by the government are for a longer period as compared to those that are issued by corporate entities.
Commercial paper is another debt market instrument that is used by various entities. A commercial paper is an uncertain and unsecured promissory note drawn by the borrower on the lender. A commercial paper is issued and accepted when it is rated by any of the credit rating agencies.
Fixed deposits are one of the most popular and rapidly growing types of debt instruments. It is the best way of earning a better rate of return and investing money for further benefits. It is more secure and safer than mutual funds or stocks and is a wonderful debt market instrument.
Types of Debt Market
There are two types of debt markets: the primary market and the secondary market. In the primary market, usually, the borrower approaches the investor who wants to raise their capital. Also, in this type of market, the price at which the bonds will be issued is already decided by the investor when raising money.
On the other hand, in a secondary market, bonds are usually traded in an investing market where the investor approaches multiple borrowers through bonds. The price of these bonds is fluctuating and keeps changing.
While understanding the difference between debt and equity, it is important to understand the meaning of both terms. Equity or equity financing refers to the process of raising capital through the issue of shares in a company. This is one of the common methods of raising funds. On the other hand, debt or debt financing refers to the process of raising capital through long-term loans in the form of debentures or bonds. This is the most used method of raising loans from the market.
The key difference between equity and debt is the following:
|Ownership||Equity shareholders are the owners of the company.||Debt holders are the company’s lenders or investors.|
|Repayment||There are no such repayment obligations||Debt is to be repaid after a specific period.|
|Interest payment||There are no interest payments due. However, regular dividends have to be paid to the equity shareholders.||Regular interest has to be paid on debts on time.|
|Security||No such security is required.||Security is given to the lender.|
|Involvement||Equity shareholders take an active role in the day-to-day activities as well as in decision-making.||Debt holders do not participate in the workings of an organization or decision-making.|
Debt or Equity: Which Is The Best Source Of Financing?
It is frequently argued that debt is a better source of financing than equity and vice versa. But, as we all know, debts are the borrowings or long-term loans of a company. If more debt is used for financing purposes, then it will increase the liability, repayment obligations, and risk of the company. It will also raise the fixed financial charges because interest on debt must be paid regularly, and the more debt there is, the higher the fixed financial charges will be.
On the other hand, if funds are raised through equity continuously, it will dilute ownership, decision-making power, and the company’s management. As we all know, equity holders are the owners of the company, and if more and more funds are raised through equity, there will be more owners of the company than needed. It will adversely affect the management as all decisions are taken with the consent of shareholders, and different shareholders have different opinions, which makes it difficult to take decisions and results in conflicts.
So, for financing purposes, there should be a proper mix of equity and debt so that funds can be raised as needed while having no negative consequences for the company.