Chapter 3
Debt Instruments
Companies, banks, central governments (such as the United Kingdom, Republic of France, etc.); local governments (such as the city of Manchester, province of Quebec, State of California, etc.) and supranational institutions (such as the World Bank, European Union, etc.) also raise cash by issuing debt instruments, also known as bonds and bills.
A debt instrument is effectively an “IOU” – a promise to pay the investor periodic amounts of interest (known as the coupon) on a loan and also the promise to return the amount borrowed to the investor at a date in the future. Unlike equities, debt instruments are usually (but not exclusively) issued for a defined period of time, after which they are said to mature. Upon maturity date the amount borrowed is returned to the investors together with the final coupon payment. As with equities, debt instruments are traded on a secondary market so that investors may buy and sell them without the involvement of the issuer.
The main differences between debt and equity finance are as follows:
- Only companies can issue equity shares, as companies can be owned by others. Central and local governments belong to society as a whole; by definition they cannot be owned by others, so when governments need to raise capital they have to use the debt markets.
- Debt instruments provide a predictable, guaranteed form of income – the interest on the bond – which is known as the coupon. The coupon is paid at regular intervals at a guaranteed ...
