Debt Security
Definition
A debt security is a financial instrument representing a loan made by an investor to a borrower, typically a corporation or government. Debt securities must be repaid at maturity and usually come with a fixed interest rate or an original purchase discount.
Key Characteristics
- Principal Amount: The borrowed amount that must be repaid by the issuer at maturity.
- Maturity: The specific date by which the principal amount must be repaid.
- Interest Rate: The fixed or variable rate paid by the borrower to the investor for the borrowed funds.
- Original Issue Discount: The difference between a bond’s face value and its lower price at issuance, providing a form of interest to the holder.
Examples
- Bills: Short-term debt instruments issued by the government with maturities of one year or less.
- Bonds: Long-term debt instruments with maturities exceeding one year, often issued by corporations or governments.
- Commercial Paper: Unsecured, short-term debt issued by corporations to meet immediate financing needs, typically with maturities of up to 270 days.
- Notes: Debt securities with intermediate maturities, generally between one and ten years.
Frequently Asked Questions (FAQs)
Q1: What is the difference between a bond and a note? A1: A bond typically has a longer maturity (more than ten years), while a note usually has a maturity period between one and ten years.
Q2: How does a debt security differ from equity security? A2: Debt securities represent borrowed money that must be repaid, whereas equity securities represent ownership in a company and generally do not have a maturity date.
Q3: Can debt securities be traded in the secondary market? A3: Yes, debt securities can often be bought and sold in secondary markets, allowing investors liquidity.
Q4: What is meant by the “yield” of a debt security? A4: The yield is the rate of return on a debt security, reflecting the interest earnings relative to the security’s current market price.
Q5: What is credit risk in the context of debt securities? A5: Credit risk refers to the risk that the issuer might default on its obligation to pay interest or repay the principal.
Related Terms
- Maturity: The expiration date of a debt security when the principal amount must be repaid.
- Interest: The periodic payment made by the borrower to the lender, usually expressed as an annual percentage of the principal.
- Commercial Paper: Short-term unsecured promissory notes issued by companies.
- Discount: The amount by which a debt security’s purchase price is lower than its face value.
Online References
Suggested Books for Further Study
- “The Bond Book” by Annette Thau
- “Debt Markets and Analysis” by R. Stafford Johnson
- “Fixed Income Analysis” by Barbara S. Petitt and Jerald E. Pinto
Fundamentals of Debt Security: Finance Basics Quiz
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