Businesses encounter several situations where they might have to make an expensive purchase or a significant investment. However, more than the company capital might be needed to fulfil the need immediately.
Companies must take out loans using bonds or credit cards on such occasions. These are different types of debt instruments.
The term ‘debt’ refers to money that is due or owed. A debt instrument is a mechanism businesses or government entities use to raise capital. Here, you can learn about the various types of debt instruments available.
What Is a Debt Instrument?
A debt instrument is a fixed-income asset used to raise capital. It legally obligates the debtor to provide the lender with principal and interest payments. The obligation is documented and details the deal’s provisions, including the interest rates, collateral involved, time frame to the maturity date and schedule for interest payments.
Debt instruments include debentures, bonds, certificates, leases, promissory notes and bills of exchange. These allow market players to shift debt liability ownership from one entity to another. Throughout the instrument’s life, the lender receives a specific amount as a form of interest.
The Different Types of Debt Instruments Available in India are:
Bonds are the most common debt securities. They are created through a contract known as bond indenture. These are fixed-income securities where an investor puts money into government or corporate assets for a fixed rate of return. Bonds appreciate when market interest rates decrease.
Corporations, municipalities and governments issue bonds. The different types of bonds in India you can invest in include corporate bonds, convertible bonds, government securities bonds, sovereign gold bonds, RBI bonds, zero-coupon bonds and inflation-linked bonds.
Businesses can invest in bonds from the primary and secondary markets. Investors can create a Demat account and a trading account with a brokerage house to buy and sell bonds of their choice. Another way to quickly buy and sell bonds is through the Yubi Invest platform. You can scroll through a list of all the available bonds and make your choice. The platform offers discovery, transaction and portfolio management services across several bond products.
Debentures are similar to bonds, except the securitisation conditions are different. To raise capital, major corporations and the government issues these debt instruments. The benefit to the issuers of debentures is that it hardly creates any claim on the assets. Therefore, it leaves them available for future funding.
Debentures appear on the balance sheet but are included in the share capital. Typically, debentures are transferrable by the debenture holder. Debenture holders are unable to vote.
3. Fixed deposits
Fixed deposits are a financial product offered by non-banking financial institutions and banks. They pay a higher rate of interest to investors than to savings accounts.
The interest or profit earned on the investment is predetermined when account holders make a fixed deposit. Therefore, regardless of changes in interest rates, the rate will not reduce or grow at any moment.
A fixed deposit account can be opened for a week to ten years in length. However, fixed deposits cannot be cashed before the expiration date. So, the money cannot be withdrawn until the deposit’s time limit has passed. Banks may levy an early withdrawal fee or penalty if the money is withdrawn before expiration.
4. Certificates of Deposit
Certificates of Deposit or CD is a specific time deposits. Financial institutions like banks provide these debt instruments to customers. CDs are equivalent to conventional bank savings accounts.
CDs are nearly risk-free and covered by insurance. They can be issued for not less than one year and not more than three years from the date of issue. They differ from savings accounts as they have set terms of 3 months, six months or 1 to 5 years. In most cases, a fixed interest rate.
5. Commercial Papers (CP)
CP or Commercial Papers are short-term debt instruments organisations use to raise capital over one year. It was first launched in India in 1990. It is an unprotected form of financial instrument issued as a promissory note.
Commercial Papers have a 7-day minimum maturity period and a maximum maturity period of one year from the date of their issue. Usually, the maturity date of this debt instrument must be, at most, the date up to which the borrower’s credit rating is applicable.
CPs are available in amounts of Rs. 5 lakh or multiples of that value. Financial institutions issue these types of debt instruments to help companies raise money. So, if you need funds, you can consider CPs.
A mortgage is a loan secured by a piece of real estate, and these debt instruments are typically used to fund the acquisition of real estate like a house, a plot of land, a commercial building, etc.
Since mortgages are annualised over time, it allows borrowers time to make payments until the debt is paid off. During the life of the loan, lenders receive interest.
A piece of real estate backs mortgages. Hence, if the borrower defaults on payments, the lender seizes the assets and sells them to recoup the loaned funds.
7. Government Securities In India
The Reserve Bank of India issues government securities or G-sec on behalf of the government instead of the Central Government’s market borrowing program.
Government securities include State Government Securities, Central Government Securities and Treasury Bills.
To finance its fiscal deficits, the Central Government borrows funds. The government’s market borrowing is increased via the issue of dated securities and 364 days treasury bills either by floatation of loans or auction. Additionally, treasury bills of 91 days are issued to seamlessly manage the temporary cash mismatches of the government.
However, these are not part of the government’s borrowing program.
Government securities are issued at face value, and since they carry a sovereign guarantee, there’s no default risk. The investor can sell the security in the secondary market, and the interest payments are made on a half-yearly basis on face value. Tax is not deducted at source, and investors can redeem the securities at face value on maturity. The maturity ranges between two to thirty years.
8. National Savings Certificate
NSC, or National Savings Certificate, is a long-term, fixed-interest instrument. The Department of Post issues NSCs. They are backed by the Government of India and are practically risk-free.
NSCs are bought from authorised post offices and have a maturity of six years. They offer an 8% annual return, and the interest is calculated every six months. Finally, it is merged with the principal amount.
NSCs, qualify for investment under Section 80C of the Income Tax Act. The interest earned every year also qualifies under 80C. There’s no tax deducted at the source. Therefore, if you are building your investment portfolio, remember NSCs.
Benefits of Debt Instruments
Debt instruments bring stability to an investor’s investment portfolio. Thanks to this, investors can expect to enjoy steady returns and even avail regular interest income through debt funds investments.
2. Lucrative returns
Investing in the different types of debt instruments helps investors gain higher returns. The returns are at least 4%-5% more than what one would gain in fixed deposits and savings bank accounts.
Fixed-income securities in India are relatively high-liquidity funds. As a result, investors can withdraw their debt funds anytime and get the amount in their bank account in less than 24 hours.
Therefore, these funds come in handy during urgent financial requirements.
4. Safer investment option
A debt instrument like corporate bonds, debentures or CPs is considered a secure and safe investment option. The transaction cost is low and not affected by market risk. It is the most significant advantage of both long-term and short-term debt instruments.
5. Taxation benefits
Another benefit of debt financing is they are not taxed every year. Tax is levied when the investor withdraws the amount from the debt fund account. Investors can also enjoy the benefits of reduced tax amounts on returns and indexation.
Debt securities or funds invest in fixed-income assets, which are less risky than equity funds. Therefore, investing in a debt instrument can help broaden one’s portfolio and meet urgent financial needs. To learn more or start investing in debt instruments, register on Yubi.
What are the four basic categories of debt instruments?
The four basic debt instruments are discount bonds, simple loans, fixed-payment loans and coupon bonds.
What is meant by debt instrument?
Debt instruments are a tool that an entity can use to raise funds. It is a binding, documented obligation to provide funds to an entity in return for a promise from the entity that the amount will be repaid to the lender or investor per the contract’s terms.
What are the options in debt instruments?
The best debt funds investment options in India are fixed deposits, debentures, bonds, certificates of deposit, commercial papers, national savings certificates, government securities in India and mortgages.