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The debt market and equity market are the two types of markets for selling and buying investments. Companies, individuals, and financial institutions are the major users of these instruments. They are means of obtaining capital for companies. As we know, one alone can’t raise capital for the establishment of their company to grow it huge. They take the help of other sources such as these debt instruments.
Let us understand what is a debt instrument. Anything that can be classified as debt and can be sold and bought is classified as a debt instrument. The main debt instruments are term loans, bonds and debentures. Equity instruments are mainly bought and sold like shares.
The securities are generally of two types, Ownership securities and creditorship securities.
Ownership securities
Ownership securities mean that the investor is a part-owner of the company. Equity shares are generally a part of ownership securities meaning that the investor who owns equity shares is a part-owner of the company and has a right to vote. Equity shareholders can demand a change in the management of the company. They generally do not have a maturity date. Equity shares have returns based on how well the company is doing.
Debt instruments indicate loans that the investor gives out a loan to the company. These investors do not have any ownership and do have a right to vote.
They cannot change the management of the company. They come mainly in the form of term loans, bonds and debentures. Creditorship securities generally have interest-based returns.
Shares
A company generally uses shares as a unit for investors. These shares can be sold or bought. Their value changes based on the market value and how the company is doing. These shares are traded among other investors. They help in maintaining the cash flow of the company. The profit that the company makes is divided and shared among the shareholders and is called a dividend.
Shares can be of multiple types: Equity shares, preference shares and deferred shares. Preference shares are a hybrid of equity and debt. They are a long term source of finance. They are also called hybrid financing instruments as they have features of equity and debt. Deferred shares or foundership, as suggested by the name, are given to the founders. These shareholders are generally given more priority and receive the dividend first.
Dividends
A corporation earning surplus distributes its profits among its shareholders, and the amount that is shared is called a dividend. A dividend is fixed for each share based on the amount of the profits. They are generally paid out in the form of currency.
Now let us understand creditorship instruments.
Creditorship securities
Creditorship securities come mostly in the form of debentures and bonds.
Bonds are a form of debt instruments issued by the corporate and are collateral or asset-based. Debentures are a type of bond which are not backed by collateral or assets. Companies generally use debentures for the expansion of their business. The investors who buy these debentures become creditors of the company and do not have any ownership.
This loan comes with a fixed interest rate depending upon the scale of the company. The company is liable to pay the investor the fixed interest irrespective of how well the company is doing. This adds to the benefit for investors as it is safer and for the company as it does not lose its ownership.
Conclusion
We have seen that there are two types of instruments, debt instruments and equity instruments. We understood the debt instruments and equity instruments. Debt Instruments are mainly debentures and bonds, while equity instruments are shares. Shares can be of different types: Equity shares, preference shares and deferred shares. The dividend is the profit distributed among its shareholders. We understood that the primary difference between a bond and a debenture comes from collaterals. While bonds are backed by collaterals, debentures are not. To understand more in detail, check out notes on types of shares.
