Debt instruments include all types of fixed-income securities promising the investors that they will receive specific cash flows at specific times in the future. Securities generating one cash flow are known as pre-discount securities or zero-coupon securities.
On the other hand, it may involve multiple cash flows. If all the cash flows are of equal amount, they are generally referred to as coupon payments.
The date beyond which the investors will no longer receive Cash flows is known as the maturity date. On this date, investors will receive the principal along with the last coupon payment.
Although these cash flows are promised, they may not be received due to the risk associated with such investments. Financial assets issued by the government, firms, and individuals often take the form of IOUs calling for fixed periodic payments, termed interest, and the repayment of the amount borrowed, termed principal. Debt instruments represent money loaned rather than ownership to the investors.
Deposits and Contracts
Currency, in real sense, is a government IOU. Money and savings accounts referred to as demand and time deposits are loans to banks and other financial institutions.
Demand and savings and other time deposits cannot be withdrawn without notice, although financial institutions provide this advantage to deposit holders.
Savings accounts draw interest, and some forms like certificates of deposits (CDs) have specific maturities. CDs pay higher interest than normal saving accounts do.
Government securities are those securities that are issued by the government to finance a deficit in the budget when revenues fall short of expenditures. Government securities are all most invariably bond issues of various types.
These bonds are issued by the government at all levels. Because it can print money, the securities of the government are not subject to default. The government securities are riskless, default-free, and earn a fixed rate of interest income.
Issued government debt securities differ in quality, yield, and maturity. In the national and international financial market, we usually find the government’s securities as mentioned below:
Treasury bills are short-term notes that mature in three months, six months, nine months, and a maximum of one year from the date of issue. These securities can be redeemed only at maturity.
Treasury bills can be easily sold in the money market at prices that reflect prevailing interest rates and on a discount basis before maturity.
The discount to the investors is the difference between the less-than-face-value price they pay and the face value they receive at maturity.
Certificate of indebtedness differs from Treasury bills because they are issued at par value and pay fixed interest rates. These fixed interest rates are called coupon rates.
Every bond issue of this type promises to pay a coupon rate of interest that is printed on the bond and never changes.
The bond investor collects this interest income by tearing perforaled coupon slip off the edge of the certificate and cashing the coupons at the banks and post offices or other government-approved authorities. The Treasury certificate matures within one year from the date of issue.
Treasury notes are similar to the treasury certificate accepted with regard to time of maturity. Notes typically have a maturity of one to ten years when they are newly issued.
Like treasury certificates, however, they are sold at face value in the money market and pay fixed coupon interest payments, each year of their life.
Treasury bonds make up the smallest segment of government debts. Bonds differ from notes and certificates with respect to maturity bonds mature and repay their face value within a period from ten to thirty years from the date of issue. Some bond issues are callable or redeemable prior to maturity.
Private debt securities are issued by corporations and/or both financial and non-financial institutions that run the spectrum in quality and yield.
The categories of these types of securities are furnished below:
When corporations go to the capital markets to obtain money for all corporate purposes, the single most important source of funds is through the sale of debt, and securities. It is a long-term written promise to pay under seal a certain sum of money at a certain time for a specific rate of interest.
Bondholders have the right to receive a fixed rate of interest payable before any dividends may be distributed to the equity owners. In addition, the bondholders have what is termed as a fixed claim on the assets of the firm.
This means that when the bonds mature, or in the event of liquidation of the firm, the bondholders are entitled to receive a stated amount and this claim has priority over any of the claims of the equity owners.
A corporate bond is a long-term debt security issued by corporations help to finance their operations. It is similar to other kinds of fixed-income securities in that it promises to make specific payments at specified times and provides legal remedies in the event of default.
Different names are often used for the same type of bond, and occasionally the same name will be used for different bonds. However, the following types of bonds are available in the financial market:
Debentures are general obligations of the issuing corporation and thus represent unsecured credit. Their claim is fixed but based only on the firm’s ability to generate cash flow.
To protect the holders of such bonds, the indenture will usually limit the future issuance of secured debt as well as any additional unsecured debt.
All interest on bonds must be paid before any dividends are distributed to the shareholders. An income bond is a security on which interest is paid only if earnings are sufficient. These are infrequently sold to raise new capital because of the residual nature of interest payments.
In some income bonds, the interest payment must be approved and declared by the board of directors as much the same way as dividends are paid on preferred stocks. If the interest on bond is not paid, it may be cumulative and payable at a later time. Income bonds are still debt instruments but they are closely related to stock in the essential characteristic of interest payment.