What is Debt ?
Debt is the money borrowed for the business. Debt securities represents the liability for the company i.e. company has the priority obligation to payback the debt amount with interest, which is the return of Investment for the lenders. It has a maturity period and borrower must repay the principal amount with interest.
Debt can involve real property, money, services, or other consideration.
Types of Debt
There are various ways for classifying debt securities. One of the common classifications of debt is based on availability of securities. Based on this, debts are of following types;
- Secured Debts: Secured debts are the types of debts which is protected by another assets or any form of guarantee for the purpose of collateral. Bank loan, car loan, home loan etc. are examples of this debt.
- Unsecured Debts: In this type of debt, any form of guarantee i.e. collateral is absent. Such debts add the risk component to the debt securities. This type of debt has relatively higher interest rates. Signature loans, student loans etc. are some examples of such loans.
- Revolving Debts: Revolving debts is an agreement where a consumer (borrower) borrows an amount up to a maximum limit on a recurring basis. A credit card is an example of this debt.
Features of Debt Securities
There are basically three main features of debt instruments:
- Maturity: Debt instruments has a predefined date where issuer must repay the principal at face value and the incurred interest during the period. Every debt arrangement must have a maturity date. Based on this, debts are:
- Short term
- Medium term
- Long term
- Coupon Rate: A coupon rate is a fixed or variable amount of annual interest income paid to debt holder, based on face value. Coupon rate is a percentage of the face value.
- Principal: Principal amount is the borrowed amount in debt financing. Principal is the face or par value of debt instruments.
Some of the common debt capital instruments are:
- Loans
A loan is a liability of money, property, or other material goods taken with a promise to payback the amount with interest as promised.
- Debentures
Debenture are unsecured bonds. Debenture is an external source of debt financing where an debenture issuing company raises money for future with a promise to pay a fixed or floating interest coupon rate of return. Debentures are generally issued by private firms.
- Bonds
Bonds are the most common and widely accepted form of debt financing used by credible corporate houses and governments. It is a fixed-income instrument and borrowers pays the interest and returns the principal on the maturity date.
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