Debt instruments are financing tools through which an entity that issues them obtains funds, in exchange for a reimbursement in a specified period and a previously agreed profitability.
Debt instruments are a series of tools through which a company, body or institution obtain financing. To do this, the entity issues a debt instrument that a buyer acquires, thus providing financing to the entity. As consideration, the entity undertakes, since it is a financial obligation, to repay the amount loaned in a given period. For this, a profitability is also agreed, which will be paid to the holder of the debt as performance for the benefit.
The most popular debt instruments are bonds, bills or promissory notes. All of them are traded on the financial markets. In this way, its ownership can alternate depending on the performance of the buyers.
Types of debt instruments
Depending on the need of the issuing company, the debt can be classified into many types. These rates are determined based on the duration of the debt instrument until its maturity, the payment scheme or its preference, among others.
Depending on the maturity of the title, we will classify the debt instrument in:
- Short-term debt instruments : These are debt instruments that are issued with a maturity of 12 months or less. That is, instruments that have a maturity of one year or less. The most common are bills and promissory notes. Depending on whether it is a company or a government, it will be a promissory note or bill, respectively.
- Long-term debt instruments : These are debt instruments that are issued with a maturity of more than 12 months. That is, they have a maturity of one year or more. The most common are bonds. Regardless of whether they are companies or not, bonds are called bonds if they refer to corporate debt and public debt. That is, if they are corporate debt, they are corporate bonds, and if they are public debt, issued by a government, they are sovereign bonds.
Additionally, each of these debt instruments may have other non-exclusive classifications. For example, a short-term zero coupon debt instrument (only one final payment is made, no periodic coupons).
Debt issuance example
Suppose a company needs $ 1,000,000 to purchase a new factory. You also want to diversify your debt with different creditors by issuing corporate bonds in the financial markets. In this way, the company decides to issue 1,000 bonds of $ 1,000 each.
The company considers that it can repay the debt, depending on the bonds that are on the market, with a 3% return. Similarly, the firm also considers that it wishes to repay the debt with a 5-year maturity term.
In this way, the operation would look like this:
- Amount specified: $ 1,000,000
- Number of bonds: 1,000
- Bonus amount: $ 1,000
- Annual interest: 3%
If the company manages to place all the debt, it will obtain the financing to build the new infrastructure. However, you will have to pay for 5 years the interest on the amount loaned, as well as the nominal amount of the bond, upon maturity of the debt instrument.