What are the types of Debt Instruments? Debt instruments include all types of fixed-income securities promising the investors that they will receive specific cash flows at specific times in the future. Securities generating one cash flow are known as pre-discount securities or zero-coupon securities. On the other hand, it may involve multiple cash flows. If all the cash flows are of the same size, they are generally referred to as coupon payments. The date beyond which the investors will no longer receive cash flows known as the maturity date. On this date, investors will receive the principal along with the last coupon payment. Although these cash flows are promised, they may not be received due to the risk associated with such investments.
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Financial assets issued by the government, firms, and individuals often take the form of IOUs calling for fixed periodic payments, termed as interest and the repayment of the amount borrowed, termed as principal. Debt instruments represent money loaned rather than ownership to the investors. What are the types of Debt Instruments?
Currency, in the real sense, is a government IOU. Money and savings accounts referred to as demand and time deposits are loans to banks and other like financial institutions. Demand and savings and other time deposits can note withdrew without notice, although financial institutions provide this advantage to the deposit holders. Savings accounts draw interest, and some forms like certificates of deposits (CDs) have specific maturities. CDs pay higher interest than normal saving accounts do.
Government securities are those securities which are issued by the government to finance the deficit in the budget when revenues fall short of expenditures. Government securities are all most invariably bond issues of various types. These bonds are issued by the government at all levels. Because it can print money, the securities of the government are not subject to default. The government securities are riskless, default-free and earn a fixed rate of interest income.
Read About the Nature of Securities Markets.
Being issued by government debt securities differ in quality, yield, and maturity. In the national and international financial market, we usually find the following governments securities:
Treasury bills are short-term notes that mature in three months, six months, nine months and maximum one year from the date of issue. These securities can be redeemed only at maturity. Treasury bills can be easily sold in the money market at prices that reflect the prevailing interest rate and on a discount basis before maturity. The discount to the investors is the difference between the less-than-face-value price they pay and face value they receive at the maturity of the bill.
Certificate of indebtedness differs from Treasury bills because they are issued at par value and pay fixed interest rates. These fixed interest rates are called coupon rates. Every bond issue of this type promises to pay a coupon rate of interest that is printed on the bond and never changes. The bond investor collects this interest income by tearing perforated coupon slip off the edge of the certificate and cashing the coupons at the banks and post offices or other government-approved authorities. Treasury certificate matures within one year from the date of issue.
Treasury notes are similar to the treasury certificate accept with regard to time of maturity. Notes typically have a maturity of one to ten years when they are newly issued. Like treasury certificate, however, they are sold at face value in the money market and pay fixed coupon interest payments each year of their life.
Treasury bonds make up the smallest segment of the government debts. Bonds differ from notes and certificates with respect to maturity; bonds mature and repay their face value within a period from ten to thirty years from the date of issue. Some bond issues are callable or redeemable prior to maturity.
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