Types of Debt Securities Overview

Types of Debt Securities

• Debt securities represent a loan from an investor to a borrower, promising a fixed return over a set period.
• Common types include bonds, notes, and commercial paper.
• Bonds typically mature in more than 10 years and are often issued by corporations and governments.
• Notes are similar to bonds but have shorter maturity periods (typically 1–10 years).
• Commercial paper is a short-term debt security issued by corporations.

Characteristics of Debt Securities

• Par Value (Face Value): The amount the issuer will repay at maturity.
• Coupon Rate: The interest rate paid on the bond, typically expressed as a percentage of the par value.
• Maturity Date: The date when the principal amount is repaid.
• Yield to Maturity (YTM): The total return anticipated on a bond if held until maturity.
• Credit Rating: An assessment of the borrower's ability to repay, influencing yield and risk. Various agencies provide credit ratings.

Bond Features

• Callable Bonds: The issuer can repay the bond before its maturity date.
• Convertible Bonds: Can be exchanged for equity shares of the issuing company.
• Zero-Coupon Bonds: Do not pay periodic interest; sold at a discount to face value, maturing at face value.

Issuers of Debt Securities

• Governments (federal, state, local): Issue bonds to finance public projects.
• Corporations: Issue bonds to raise capital for business development.
• Agencies like the Federal Housing Administration (FHA): Issue securities backed by government guarantees.

Risks Associated with Debt Securities

• Interest Rate Risk: Changes in market interest rates affect security prices.
• Credit Risk (Default Risk): Risk that the issuer won't repay the debt.
• Inflation Risk: Interest income might not keep pace with inflation, reducing real return.
• Liquidity Risk: Risk that a security can't be easily sold at a fair price.
• Call Risk: Risk associated with bonds that issuers may redeem early.

Debt Security Market

• Primary Market: New debt securities are issued and sold to investors.
• Secondary Market: Existing debt securities are traded among investors; exchanges like the NYSE are part of this market.
• Over-the-Counter (OTC) Market: A decentralized system where securities are traded directly between buyers and sellers via dealers.

Debt Security Valuation

• Debt security value depends on prevailing interest rates, issuer creditworthiness, and maturity.
• Discounted cash flow analysis determines the present value of future cash flows from the bond.

Key Considerations for Investors

• Risk Tolerance: Assess comfort level regarding potential losses.
• Investment Objectives: Align investment decisions with personal financial goals.
• Diversification: Spread investments across different debt instruments, minimizing risk.

Government Bonds

• Issued by a government to fund public spending or projects.
• Often backed by the government's full faith and credit.
• Consider interest rates and economic trends.

Corporate Bonds

• Issued by a corporation to raise capital for business purposes.
• Rated to assess creditworthiness.
• Consider company performance and financial history.