Debt Instrument

Add-On Interest

What is a debt instrument?

A debt instrument is a tool that an entity can use to raise capital. It is a documented and binding obligation that provides funds to an entity in exchange for a promise by the entity to repay a lender or investor in accordance with the terms of a contract. Debt instrument contracts include detailed transaction arrangements, such as the guarantees involved, the interest rate, the interest payment schedule and the time to maturity, if any.

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What are debt instruments?

Understanding debt instruments

Any type of instrument mainly classified as debt can be considered a debt instrument. Debt instruments are tools that an individual, government entity, or business entity can use to raise capital. Debt instruments provide capital to an entity that promises to repay the capital over time. Credit cards, lines of credit, loans and bonds can all be types of debt instruments.

In general, the term debt instrument mainly focuses on debt capital raised by institutional entities. Institutional entities can include governments and private and public companies. For financial accounting purposes, the generally accepted accounting principles (GAAP) of the Financial Accounting Standards Board and the International Financial Reporting Standards (IFRS) of the International Accounting Standards Board may have certain requirements for reporting different types of debt instruments in an entity’s financial statements.

The issue markets of institutionalized entities vary considerably depending on the type of debt instrument. Credit cards and lines of credit are a type of debt instrument that an institution can use to obtain capital. These revolving lines of credit generally have a simple structure and a single lender. They are also generally not associated with a primary or secondary securitization market. More complex debt instruments will involve advanced contract structuring and the participation of multiple lenders or investors, typically investing through an organized market.

Structuring and types of instruments

Debt is generally a top choice for raising institutional capital, as it comes with a defined repayment schedule and therefore lower risk, which helps reduce interest payments. Debt securities are a more complex type of debt that involves more structuring. If an institutional entity chooses to structure the debt in order to obtain capital from several lenders or investors via an organized market, it is generally characterized as a debt guarantee instrument. Debt securities are complex and advanced debt instruments structured to be issued to multiple investors. Some of the most common debt security instruments include: US treasury bills, municipal bonds and corporate bonds. The entities issue these debt securities because the structuring of the issue makes it possible to obtain capital from several investors. Debt securities can be structured with short or long term maturities. Short-term debt securities are reimbursed to investors and closed within one year. Long-term debt securities require payments to investors for more than a year. The entities generally structure the offers of debt securities for repayments ranging from one month to 30 years.

Below is a breakdown of some of the most common debt guarantee instruments used by entities to raise capital.

American treasures

US treasury bills come in many forms represented on the US Treasury yield curve. The US Treasury issues debt guarantee instruments with one month, two months, three months, six months, one year, two years, three years, five years, seven years, 10 years, 20 years. years and 30 years. Each of these offers is a debt guarantee instrument offered by the United States government to the general public for the purpose of raising capital to finance the government.

Municipal bonds

Municipal bonds are a type of debt guarantee instrument issued by US government agencies to finance infrastructure projects. Investors in municipal bond securities are mainly institutional investors such as mutual funds.

Corporate bonds

Corporate bonds are a type of debt instrument that an entity can structure to raise capital from the broader investing public. Institutional mutual fund investors are generally among the largest corporate bond investors, but individuals with access to brokerage may also be able to invest in the issuance of corporate bonds. Corporate bonds also have an active secondary market which is used by both individual and institutional investors.

Companies structure corporate bonds with different maturities. The structuring of the maturities of a corporate bond is a determining factor in the interest rate offered by the bond.

Alternative structured debt guarantee products

There are also a variety of alternative structured debt products in the market, primarily used as debt instruments by financial institutions. These offers include a set of assets issued as debt securities. Financial institutions or financial agencies can choose to combine the products of their balance sheet in a single offer of debt securities. As a security instrument, the offer raises capital for the institution while separating the pooled assets.

Key points to remember

  • Any type of instrument mainly classified as debt can be considered a debt instrument.
  • A debt instrument is a tool that an entity can use to raise capital.
  • Companies have flexibility in the debt instruments they use and in the way they choose to structure them.

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