What Are Financial Notes?
A note is a legal document serving as an IOU from a borrower to a creditor or investor. Notes have similar features to bonds, offering interest payments to the investor and repaying the principal—the original amount invested—at a future date.
Notes can obligate issuers to repay creditors the principal amount of a loan, along with any interest payments, on a predetermined date. These financial instruments have diverse applications, ranging from informal loan agreements between family members, safe-haven investments, and complex corporate debt instruments.
Key Takeaways
- A note is a legal document representing a loan made from an issuer to a creditor or an investor.
- Notes entail the repurchase of the principal loaned, as well as any predetermined interest payments.
- The government issues Treasury notes (T-notes) to finance projects such as building infrastructure.
The Mechanics of Financial Notes
A note is a debt security obligating repayment of a loan at a specified interest rate within a set time frame. Although similar to bonds, notes typically have earlier maturity dates. For example, a note may pay an interest rate of 2% per year and mature in one year or less, while a bond might offer a higher interest rate but won’t mature for several years.
Notes can signify various loan arrangements. For instance, a demand note has no fixed repayment schedule and can be called in for repayment at any time. This type of note is often used in informal lending agreements, such as those between family members or friends.
Notes can even serve as currency. Euro notes, for example, are legal tender paper banknotes used in the eurozone, available in various denominations like five, 10, 20, and 100 euros.
Notes as Investment Vehicles
Some notes serve as investment tools. Mortgage-backed notes, for example, are asset-backed securities where mortgage loans are bundled into a fund and sold as an investment. Investors earn interest payments based on the rates of the underlying loans.
Structured notes combine the characteristics of a bond with an added derivative component, like an equity index. These notes offer fixed interest payments from the bond as well as possible additional returns if the equity part performs well.
Capital notes are examples of unsecured, short-term debt issued by companies. Some notes offer tax benefits, such as municipal notes issued by state and local governments for infrastructure projects. These notes usually mature within a year and can offer tax advantages.
Safe-Haven Investments
Treasury notes (T-notes) are popular secure investments issued by the government. These notes, issued in $100 increments, pay interest at six-month intervals and return the face value upon maturity. T-notes come with maturity dates ranging from two to 10 years, making them longer-term than Treasury bills but shorter-term than Treasury bonds.
Other Types of Notes
Unsecured Note
An unsecured note is a corporate debt instrument without collateral, generally issued for periods lasting from three to 10 years. For instance, Company A might issue unsecured notes to raise $18 million for acquiring Company B. Without collateral, these notes carry higher risk but offer higher interest rates to compensate.
Promissory Note
A promissory note provides written documentation of a loan, including terms like repayment schedule and interest rate. The borrower signs the note, signifying their commitment to repay the loan to the lender.
Convertible Note
A convertible note usually serves as a funding tool for startups without clear valuations. These notes start as loans and convert to equity when new investments are made. Early investors may receive additional shares to compensate for higher initial risks.
Related Terms: bonds, principal, demand note, asset-backed security, structured notes.
