A debt instrument is any financial tool used to raise capital. It involves a documented, binding obligation between two parties in which one party lends funds to another, with the repayment method specified in a contract. Some are secured by collateral, and most involve interest, a schedule for payments, and a time frame to maturity if it has a maturity date.
Key Takeaways
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Any type of instrument primarily classified as debt can be considered a debt instrument.
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A debt instrument is a tool an entity can use to raise capital.
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Businesses have some flexibility in their debt instruments and how they structure them.
What Defines a Debt Instrument?
Any type of instrument primarily classified as debt can be considered a debt instrument. Generally, the instruments used are some form of term debt, credit, or other revolving debt—credit instruments that you can continually draw on—with repayment conditions defined in a contract. Credit cards, lines of credit, loans, and bonds can all be considered debt instruments.
A debt instrument typically focuses on debt capital raised by governments and private or public companies. The issuance markets for these entities vary substantially by the type of debt instrument.
Credit cards and lines of credit can be used to obtain capital. These revolving debt lines usually have a simple structure and only one lender. They are also not typically associated with a primary or secondary market for securitization. More-complex debt instruments involve advanced contract structuring, multiple lenders, and investors typically invest through organized marketplaces.
Types of Debt Instruments
Debt is typically a top choice for raising capital because it comes with a defined schedule for repayment. This implies less risk for both the lender and borrower, facilitating lower interest payments. Debt securities are a more complex debt instrument involving greater structuring. When a business structures its debt to obtain capital from multiple lenders or investors through an organized marketplace, it is usually characterized as a debt security instrument. These are complex as they are structured for issuance to multiple investors.
Common Debt Security Instruments:
U.S. Treasury Bonds
Treasury bonds are diverse and spread across a yield curve. The U.S. Treasury issues three types of debt security instruments: Bills, Notes, and Bonds:
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Treasury bills have maturities ranging from a few days to 52 weeks.
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Treasury notes are issued with two-year, three-year, five-year, seven-year, and 10-year maturities.
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Treasury bonds have 20-year or 30-year maturities.
Each of these offerings is a debt security instrument the U.S. government offers to the public to finance government operations.
Municipal Bonds
Municipal bonds are a type of debt security instrument issued by state and local governments to fund infrastructure projects. Institutional investors, such as mutual funds, typically invest in municipal bonds.
Corporate Bonds
Corporate bonds are used by companies to raise capital from the public. These bonds have different maturities that affect their interest rates.
Mutual funds are usually among the prominent corporate bond investors. Additionally, retail investors with a brokerage account can also invest in corporate bonds through their broker. They also have an active secondary market accessible to both retail and institutional investors.
Alternatively Structured Debt Security Products
Various alternatively structured debt security products exist in the market, primarily utilized by financial institutions. These include bundled assets issued as debt securities.
Financial institutions and agencies may choose to bundle products like debt from their balance sheets into a single security, using it to raise capital while segregating the assets.
Frequently Asked Questions
What Is a Debt Instrument?
A debt instrument is used to raise capital. It includes a binding contract where one entity borrows funds from a lender and promises to repay them according to the agreed terms.
What Is a Debt Security?
A debt security is a more complex form of debt with an elaborate structure, allowing the borrower to raise money from multiple lenders through an organized marketplace.
What Are Treasury Bonds?
The U.S. government issues Treasury bonds to raise capital. These come with maturities of 20 or 30 years. Additionally, Treasury bills come with maturities ranging from a few days to 52 weeks, and Treasury notes have maturities of two, three, five, seven, or 10 years. All these instruments are forms of debt.
The Bottom Line
Debt instruments are utilized to raise capital for businesses and governments. Various types of debt instruments exist, but the most common forms include credit products, bonds, or loans. Each has different repayment conditions, generally outlined in a contract.
Related Terms: Financial instruments, Debt securities, Credit instruments.
References
- PwC. “Financing Transactions”, Page 1-2 and 1-9.
- TreasuryDirect.gov. “Treasury Securities & Programs”.
- U.S. Securities and Exchange Commission. “Municipal Bonds”.
- U.S. Securities and Exchange Commission. “What Are Corporate Bonds?”
- MutualFunds.com. “Top 763 Corporate Bond Funds”.
- TD Ameritrade. “Fixed Income Investments Can Help Address Your Income Needs”.
- Vanguard. “Trading on the Primary and Secondary Markets”.
- Office of the Comptroller of the Currency. “Comptroller’s Handbook | Asset Securitization”, Pages 1-13. Click Download PDF.
