What are Debt Securities?

Debt securities are a type of investment that give the holder a claim on a company’s financial obligations to either borrow money from the public or from another firm. This means, if you have invested in debt securities, then you will be entitled to receive interest payments and repayment of your principal when the obligation matures.

How do debt securities work?

Debt securities work by giving the debt holders a claim on assets or earnings of the company. The firm will use money for paying back its debts in accordance with the terms and conditions mentioned in their bond agreement.

Types of Debt Securities

There are many different types of debt securities that you can invest in. Some examples include:

– Commercial Paper

Commercial Paper is an unsecured promise to pay a certain amount on a stated maturity date, issued in bearer form. The commercial paper is issued at a discount, and no interest payments are made. The company will repay the principal amount of its debt security when it matures.

– Corporate Bonds

Corporate bonds are long-term debt securities which have a maturity date beyond one year from issuance. Interest rates on corporate bonds can vary depending on their credit rating and other factors.

– Government Bonds

Government bonds are issued by the national governments or their agencies and pay interest to bondholders until maturity, which is typically between one and ten years from issuance. These debts can be denominated in various currencies depending on where they were issued, but it should always be noted that government debt securities sometimes have negative yields.

– Municipal Bonds

Municipal bonds are issued by states, counties, or cities and provide tax exemptions to investors who buy them. They typically have a higher credit rating than corporate bonds because they are backed by the taxing power of their issuing entity. Interest rates on municipal securities fluctuate depending on market conditions but can be as high as 14%.

– Treasury Bills/Bonds (T-bills/T-notes)

Treasury bills are short term debt securities which mature within one year. T-bills do not pay interest but instead, provide investors with the face value of money back when they mature. Similar to commercial paper, these debts can be denominated in various currencies depending on where they were issued.

Risks in Investing in Debt Securities

One of the main risks when investing debt securities is interest rate risk, which means that your return will be dependent on changes to market interest rates over time. If you choose longer-term debt securities like government bonds or corporate bonds with maturities beyond one year, there is also credit risk of default.

Benefits in Investing in Debt Securities

Debt securities are flexible and can be purchased on margin with borrowed money to increase returns while maintaining a certain amount of diversification within your portfolio. These types of investments may also provide higher yields than other debt instruments like savings accounts or CDs.

Steps in Investing in Debt Securities

When investing debt securities, you can choose to either purchase them directly from the issuer or through a broker. If purchasing these instruments on margin, it is important that you understand all of your rights and obligations as an investor when doing so. You should also be aware that when selling bonds before maturity, you will likely have to pay a commission fee and may incur capital gains taxes.

 

True is a Certified Educator in Personal Finance (CEPF®), contributes to his financial education site, Finance Strategists, and has spoken to various financial communities such as the CFA Institute, as well as university students like his Alma mater, Biola University, where he received a bachelor of science in business and data analytics.

To learn more about True, visit his personal website, view his author profile on Amazon, his interview on CBS, or check out his speaker profile on the CFA Institute website.