Debt Market: Meaning, Issuers, Instruments, Advantages, Disadvantages, and More

Debt Market: Meaning

Debt Market is a market place, where buying and selling of debt market financial instruments take place. These financial instruments are fixed-income securities, giving fixed returns to the investors. These securities provide regular interest payments at a fixed rate with principal repayment at the time of maturity. The issuer of these securities can be local bodies, municipalities, state government, central government, corporate, etc. Major Debt Market securities are Bonds, Government Bonds, Debentures, Treasury Bills, Certificate of Deposits, Commercial Papers, etc.

In Debt Market, the creditworthiness of the issuer plays a very important role. Credit Rating agencies like Moody’s, Standard & Poor’s, Fitch, ICRA, etc give credit ratings to all these debt securities according to their credibility. Investors rely heavily on these ratings, before investing in debt securities.

Fixed-Income Market or Credit Market is the other name of the Debt Market.

Who issues Debt Market Instruments?

The debt market is one of the important platforms for raising debt. Debt Market Instruments helps the issuers to procure funds and satisfy their needs. Many entities issue Debt Market instruments, which are as follows:-

Corporate/ Companies

Companies often rely on debt instruments to finance their projects, expansion, or growth. Raising money through equity is always not a feasible option, in such a situation the companies go for Debt Market securities.

Banks and Financial Institutions

Banks and Financial Institutions flourish on deposits and lending business. Debt Market instruments give Banks and Financial Institutions, an opportunity to raise funds for lending. These institutions and banks accept deposits from the public at large at a lower interest rate and thereafter lends money to the borrowers at a higher rate.

State and/or Central Government

The State and/or Central Government raises money through Debt Market instruments to execute its various infrastructural projects and welfare programs. Sometimes the government does not have enough funds even after considering all taxes income and other incomes. In such a situation, the government raises funds through the general public. The infrastructural projects once start functioning, they repay the government and the same funds are given back as returns and redemptions to investors.

Local Panchayats or/and Municipal Corporations or/and Local Body

At even small town or village level, Debt instruments are useful for raising funds. In a similar manner to Central and State Government, these local Municipalities or Village Panchayats use these instruments for collecting funds for their infrastructural projects and other welfare programs.

Public Sector Units (PSUs)

Public Sector Units (PSUs), have to directly compete with private entities. These Units also use debt instruments to raise funds for their projects and expansion.

Types of Debt Market Instruments

In the Debt Market, the trading of many securities takes place. All these securities individually have a different set of qualities and serve different purposes. All those issuers of these securities according to their financial requirements and available options selects the best debt instrument. They are as follows:-

Bonds

Bonds are mainly of two types, i.e. Government Bonds and Corporate Bonds. Government Bonds holds less risk than Corporate Bonds. Mostly, Corporate Bonds pay a higher interest rate than Government Bonds. There are other Bonds like Municipal Bonds and Institutions Bonds. The Bonds have a fixed coupon rate and pay that interest to the bondholder periodically. And also repay the principal amount at the time of maturity. The interest rates of bonds are variable in the case of Floating Rate Bonds.

Floating Rate Bonds provide a variable interest rate that fluctuates according to the changes in the interest rates in the economy. Fixed-Rate Bonds gives fixed interest rates, irrespective of any market changes. There are Zero-Coupon Bonds, which does not provide any interest rate periodically or at the time of redemption. Rather These bonds are issued at a discount to the par value or face value of the bond. And the redemption of such bonds at maturity at the par value of the bond. The difference between the par value and the discount value is the return for the investor or we can say that is the interest for the bondholders.

Issuance of Corporate Bonds sometimes takes place with a call option and put option. In the case of a call option, the company can call back their bonds once a particular time has passed. In the case of a put option, the investors can sell their bonds, back to the company after a particular time or date as indicated at the time of issuance.

Government Securities

These are debt instruments, mostly issued by the Central Bank of the country, in the place of the Central or State Government. These securities can be for the long term or short term. These securities give a fixed coupon rate to the investors. The yield of Government securities are mostly considered as a benchmark for return and are even considered as a risk-free rate. Treasury Bills are short-term securities. Long term Government securities include instruments like Dated Securities or Bonds.

Debentures

Debentures are similar in nature to Bonds; the only difference is the security level. Debentures are riskier in nature. Not only this, Bonds can be issued by the Government and Companies, but Debentures can only be issued by Companies. Debentures can be of different types, which are as follows:-

Registered Debentures and Bearer Debentures

The Registered Debenture is there in the company’s records. The names of the debt holders and other details are recorded in the company and the repayment of the debenture is made to that particular name only. These debentures are transferable but need to complete the transfer process. Recording of Bearer Debentures does not take place. The issuer of the Debenture is entitled to make the repayment of the bond amount to whoever holds the debenture certificate.

Secured Debentures and Unsecured Debentures

Secured Debentures are backed by collateral security. The Unsecured Debentures have no backing of any collateral security. Secured are less risky in comparison to the Unsecured ones.

Redeemable Debentures and Non-Redeemable Debentures

Redeemable Debentures are repaid at the time of maturity only. Repayment of Non- Redeemable Debentures takes place at the time of liquidation only.

Convertible Debentures and Non-Convertible Debentures

Convertible Debentures can be converted into equity shares on a future date. Non-Convertible Debentures cannot be converted into equity shareholders on any future date.

First Debentures and Second Debentures

At the time of liquidation, First Debentures have the preference over the Second Debentures at the time of repayment.

The above-mentioned list does not include all debt market instruments available in the market. Other instruments are Fixed Deposits, Certificates of Deposits, Commercial Papers, National Savings Certificates, etc.

Debt Market

Types of Risks in Debt Markets

Debt Markets, in comparison to other markets, are less risky in nature. Irrespective of that there are few risks, which are difficult to ignore.

Credit Risk or Default Risk

One of the biggest risks in this market is the default risk or credit risk of the issuer. It might happen, due to unforeseen situations, the issuer loses its credibility and is not able to repay back the interest and/or principle. Though the debt securities get first preference at the time of liquidation, it is one of the biggest risks for the investors.

Interest Rate Risk

This type of risk prevails almost in all debt market securities. The interest rates of debt instruments continuously fluctuate in the open markets. There are times when there is a high-interest rate in the market but the investor has invested for a lower fixed interest rate. In such a situation, the investors lose on to higher interest rates and get only the fixed interest rate.

Settlement Risk and Liquidity Risk

Settlement of the debt security at times, acts as a risk, as the other party might not fulfill all requirements. There exist counterparty issues at the time of settlement.

Liquidity Risk acts as an area of concern in the case of debt securities. Sometimes premature withdrawals are not an easy task to conduct. Premature withdrawals not always provide ideal returns on their investments

There can always be other risks, associated with the Debt instruments.

Advantages of Debt Market

  • The debt market capitalizes and mobilizes the funds in the economy.
  • This market gives a platform to the government, companies, and other bodies to raise funds.
  • Sometimes raising equity becomes very costly for the corporate. In such a situation raising money through the debt market is the best possible option.
  • This market gives fixed returns to investors with lesser risk. Government Debt Market securities are less risky than Corporate Debt securities.
  • In absence of any other sources of finances, the Central/State Government takes the help of this market. It saves the Government bodies, from suffering from any cash crunch.
  • Debt Market securities backed by assets get the preference as compared to other unsecured and business debts, at the time of liquidation.
  • The money raised through this market helps the companies to boost its expansion and growth plans.
  • The debt market helps the Government authority to boost infrastructural projects.

These advantages are non-exhaustive in nature.

Disadvantages of Debt Market

  • One of the biggest disadvantages of this market is that it provides fixed returns to the investors and completely ignores the inflation rate. The inflation can make the actual return falls down to a record low.
  • The second disadvantage is, in the case of premature withdrawal or sell-off in the market, the investor gets the current market bond’s price and not the principal amount invested. It is possible that the company might lose its credibility and the bond prices might have fallen down.
  • The investors will get a fixed interest rate return only, irrespective of an increase in the interest rate in the market.
  • For issuing authority, it becomes very difficult to get a good credit rating. This becomes the biggest task to meet all requirements of credit rating agencies.

These disadvantages are non-exhaustive in nature.

Debt Market Vs Equity Market

There are many differences between the Equity Market and Debt Market, which are as follows:-

Debt MarketEquity Market
A debt market is a market place, where fixed-income securities are traded.Equity Market is a market place where trading of equity stocks takes place.
Investors in the Debt Markets are known as Debt holders.Investors in the Equity Markets are known as shareholders or Equity holders.
Debt holders have first repayment priority at the time of liquidation.Equity holders or shareholders have the last repayment priority at the time of liquidation.
Debt holders are creditors of the company.Equity holders are owners of the company.
Debt holders do not have any voting rights.Equity holders have voting rights in the company.
Instruments of the debt market provide fixed returns to the investors.Equity Market does not guarantee any fixed returns.
Debt Market instruments are less volatile in nature. They are less risky than Equity Market.Equity Markets are very volatile in nature. They are riskier.
Debt Market holders get interest rates, for their investments.Equity Market holders get dividends and not interest rates.
Debt Market Vs Equity Market

These differences are non-exhaustive in nature.

Conclusion

The debt market is one of the important market place, which keeps the economy running. It channelizes the funds in a productive way and benefits the issuer and the investor. Starting from Government to Corporate uses this market as a source of finance. For investors, it acts as a fixed- regular source of income.

Sanjay Bulaki Borad
Sanjay Bulaki Borad

Sanjay Borad is the founder & CEO of eFinanceManagement. He is passionate about keeping and making things simple and easy. Running this blog since 2009 and trying to explain "Financial Management Concepts in Layman's Terms".

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