Debt securities are a type of investment that provides fixed income to the investor in the form of regular interest payments. Unlike stocks, securities give holders the right to earn both principal and interest on their investment. If you want to diversify your investment portfolio and put your money in a lower-risk investment, debt securities might be for you.
In this article, we’ll cover the main features of debt securities and its most common type: the bond.
Let’s get to the following commonly asked questions:
- What are debt securities?
- What are the two types of debt securities?
- Are debt securities the same as loans?
- debt securities vs equity securities: what’s the difference?
- What are examples of debt securities?
Q1. What are debt securities?
Debt securities, such as bonds issued by governments or corporations, are debt instruments that can provide investors with a steady stream of income. One of the key features of debt securities is that they have specific maturity dates, which can vary depending on the type of security. Buying debt securities can be a smart investment strategy for those looking for a predictable and reliable source of income. The rate of return on debt securities can vary depending on factors such as the creditworthiness of the issuer and the length of the maturity date. However, regardless of the specific terms, investing in debt securities can provide a steady stream of income for the duration of the security's maturity period.
Essentially, they are a financial instrument that includes a promise from the issuer to pay the holder a specific amount by a certain date, for instance, when the equity security matures. Since they are also negotiable, they can quickly be passed between owners.
Note: The most common type of debt security is bonds, including municipal, corporate, and government bonds, as well as preferred stock, collateralised debt obligations, and collateralised mortgage obligations.
Q2. What are the two types of debt securities?
The two main examples of debt securities are:
- Bonds & notes: Also known as medium-term notes, these are often issued on a standalone basis and allow an issuer to make multiple issues through one principal document.
- High-yield securities: These are bonds issued by non-investment issuers and are often subordinated to other debts of the issuer. Because they are a riskier form of debt security, you’ll accumulate more interest than an investment-grade bond.
Q3. Are debt securities the same as loans?
Loans are not typically classed as debt securities, as they tend to have a lower interest rate. While a bank loan is a non-negotiable financial instrument, debt security usually has a more flexible interest rate, including fixed, floating, or zero coupons.
A loan consists of money that an individual or business borrows from banks or financial institutions and typically has structured payment dates. The principal amount is paid to the borrower in instalments over time.
In comparison, debt securities are money that a business raises using the issuance of bonds. The investor in the bond will then receive a regular stream of income through interest payments until the bond matures. Once the bond matures, the investor will have the entire principal amount returned to them in the form of a lump sum.
Q4. Debt securities vs equity securities: what’s the difference?
Equity investments or securities refer to the claim an individual or business has on a corporation’s earnings or assets, whereas debt securities are investments in debt instruments. For instance, preferred stocks are equity securities, while bonds are debt security.
Important: When buying debt securities like corporate bonds, investors have the right to be repaid both the principal and interest. Whereas when buying stocks, investors are buying a piece of the company, making it one of the riskier investment options.
Q5. What are examples of debt securities?
Debt securities are generally considered a lower-risk investment compared to buying stocks. If you’re interested in diversifying your investment portfolio through alternative investments, there are many types of debt securities that you can earn fixed income streams from.
Examples of investments in debt security include:
- Bonds: Securities that are issued by corporations and government agencies, and bonds are used to raise money for projects or needs. Bonds are most often sold for the amount the issuer is borrowing, however, prices can vary depending on market interest rates. Maturity can happen from one month to up to 30 years, at which point the corporation must repay the debt. Risk levels depend on the financial stability of the bond issuer.
- Preferred stocks: These are hybrid securities sharing similarities with stocks and debt securities. Preferred stocks are issued at face value, and investors are paid dividends based on the amount. Their market value can fluctuate depending on the corporation’s performance, making the initial investment risker than bonds, however, the rate of return is often higher.
- Commercial paper: Larger businesses will sometimes use commercial paper for the purposes of financing short-term obligations. Typically, commercial paper securities reach their maturity dates after 270 days and sell at a discount before maturing to their face value. This is one of the more cost-effective ways to invest in debt securities.
- Mortgage-backed securities: When a company buys mortgage loans from lenders and pools them together into one package, a mortgage-backed security is created. These debt securities are backed by homes used to secure individual loans and payout in regular amounts based on a predetermined interest rate.
Summing up
Debt securities are one of the less risky investment strategies available to individuals, allowing them to earn regular income payments before the bond matures. The most common types of debt securities include corporate bonds, mortgage-backed securities, and commercial paper.
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Disclaimer: The author is not a financial advisor and the information provided is general in nature and was prepared for information purposes only. This article should not be considered to constitute financial advice. Accordingly, reliance should not be placed on this article as the basis for making an investment, financial or other decision. This information does not take into account your investment objectives, particular needs or financial situation.
