A debt instrument is a fixed income asset that allows the lender (or giver) to earn a fixed interest on it besides getting the principal back while the issuer (or taker) can use it to raise funds at a cost. Debt acts as a legal obligation on the issuer (or taker) part to repay the borrowed sum along with interest to the lender on a timely basis. A debt instrument can be in paper or electronic form. Bonds, debentures, leases, certificates, bills of exchange and promissory notes are examples of debt instruments.
These instruments also give market participants the option to transfer the ownership of debt obligation from one party to another. The lender receives a fixed amount of interest during the lifetime of the instrument.
Debt instruments provide fixed and higher returns, thus giving them an edge over bank fixed deposits. The duration of debt instruments can either be long-term or short-term. Funds raised through short-term debt instruments are to be repaid within a year.
However, long-term debt instruments are the ones that are paid over a year or more. Credit card bills and treasury notes are examples of short-term debt whereas long-term loans and mortgages form part of long-term debt instruments.
Some of the common types of the debt instrument are:
1. Debentures
Debentures are not backed by any security. They are issued by the company to raise medium and long term funds. They form the part of the capital structure of the company, reflect on the balance sheet but are not clubbed with the share capital.
2. Bonds
Bonds on the other hands are issued generally by the government, central bank or large companies are backed by a security. Bonds also ensure payment of fixed interest rates to the lenders of the money. On maturity of the bond, the principal amount is paid back. Bonds essentially work the way loans do.
3. Mortgage
A mortgage is a loan against a residential property. It is secured by an associated property. In a case of failure of payment, the property can be seized and sold to recover the loaned amount.
4. Treasury Bills
Treasury bills are short-term debt instruments that mature within a year. They can be redeemed only at maturity. They are sold at a discount if sold before maturity.
FAQs
A debt instrument is an asset that individuals, companies, and governments use to raise capital or to generate investment income. Investors provide fixed-income asset issuers with a lump-sum in exchange for interest payments at regular intervals.
What are examples of debt instruments? ›
Debt instruments include debentures, bonds, certificates, leases, promissory notes and bills of exchange.
What financial instrument is a debt instrument? ›
Debt instruments are any form of debt used to raise capital for businesses and governments. There are many types of debt instruments, but the most common are credit products, bonds, or loans. Each comes with different repayment conditions, generally described in a contract.
What is a debt instrument What is the claim to income on a debt instrument? ›
A debt instrument is a fixed-income asset that legally obligates the debtor to provide the lender interest and principal payments. Accessing debt financing requires the debtor to pay the creditor according to pre-defined contractual terms.
What are debt instrument terms? ›
Debt instruments include critical information such as the loan terms, the interest rate and repayment schedule, the loan amount, and any additional fees associated with the loan. The primary importance of such instruments is that they provide evidence of a debt owed.
Are debt instruments risky? ›
Investments in debt securities typically involve less risk than equity investments and offer a lower potential return on investment. Debt investments fluctuate less in price than stocks. Even if a company is liquidated, bondholders are the first to be paid.
Which of the following are not examples of debt instruments? ›
Answer and Explanation:
Examples of debt instruments are loans, discount bonds, premium bonds and zero-coupon bonds. On the other hand, common stocks and preferred stocks are examples of equity instruments.
What is another word for debt instrument? ›
Definitions of debt instrument. a written promise to repay a debt. synonyms: certificate of indebtedness, obligation.
What is the difference between a debt instrument and a loan? ›
It is a kind of debt instrument. It is a way for the government or a company to raise money by selling, in effect, IOUs – with interest payments annually. A loan is another kind of debt instrument provided by a bank, mostly private, with a variable interest rate.
What are listed debt instruments? ›
These include all medium and long-term debt securities such as debentures, bonds (including convertible bonds/Non-Convertible Bonds) and fixed deposits. The primary focus of the rating exercise is to assess future cash generation capability and their adequacy to meet debt obligations in the future.
Bonds are issued by governments or businesses. Investors pay the issuer the market value of the bond in exchange for guaranteed loan repayment and the promise of scheduled coupon payments. This is the annual rate of interest that a bond pays. It is generally expressed as a percentage of the bond's face value.
What is a debt instrument IRS? ›
The term “debt instrument” means any instrument or contractual arrangement that constitutes indebtedness under general principles of federal income tax law (including, for example, a bond, debenture, note, certificate, or other evidence of indebtedness). It generally does not include an annuity contract. Issue price.
What is an evidence of debt instrument? ›
Evidence of debt means a writing that evidences a promise to pay or a right to the payment of a monetary obligation such as a promissory note; bond; negotiable instrument; loan, credit, or similar agreement; or monetary judgment entered by a court of competent jurisdiction.
What is an example of a debt instrument? ›
A debt instrument is a specific type of tool that a company can use to help raise additional capital. These include government bonds and corporate bonds, for example. Non-debt instruments include investments in equity in incorporated companies and capital participation in limited liability partnerships.
Is cash a debt instrument? ›
Cash is the definition of liquid and inherently provides no return - you could earn interest on cash by depositing it in a bank but then you are creating a debt obligation in effect - the cash inherently, as in cash in a physical safe, generates zero return nominal by definition.
What are the features of debt instrument? ›
Summary
- Debt securities are negotiable financial instruments, meaning they can be bought or sold between parties in the market.
- They come with a defined issue date, maturity date, coupon rate, and face value.
- Debt securities provide regular payments of interest and guaranteed repayment of principal.
Equity securities, for example, common stocks. Fixed income investments are debt instruments, such as bonds, notes, and money market instruments, and some fixed income investments, such as certificates of deposit, may not be securities at all.
Is fixed deposit a debt instrument? ›
Although Fixed Deposits and Debt Mutual Funds are debt instruments, there are quite a few differences in how they are taxed. The first and perhaps the most fundamental difference is when the returns are taxed. In the case of Fixed Deposits, the entire interest earned is subject to tax for the applicable financial year.
