A Guide to Common Debt Instruments

A common aphorism is that “money makes the world go round”. Those uttering it often don’t specify what particular aspect of money does the heavy lifting, but it can be easily argued that without debt, modern society couldn’t function. It’s almost as old as civilisation itself, but debt instruments have gotten plentiful and increasingly sophisticated. If you’re at all confused about how some of the major instruments work, read on!

1. Bonds

If you follow financial news, you might have read about the bond market being in a very bad state at the moment, but what does that mean? A bond is a secure contract where an entity offers a fixed rate of return for some investment. It is commonly a tool used by governments to control inflation, but it can be used by companies (most successfully blue-chips), who can issue bonds to support capital expenditure or just for working capital.

An indenture is essentially a contract between an entity issuing a bond and a bond holder. The indenture will list specific features of a debt offering, including the maturity date, interest details, and coupon payments, and can be issued by both companies and governments. Coupon payments are payments that are issued periodically by those issuing the bond.

2. Debt Factoring

Debt factoring is a crucial tool for businesses. According to fundinvoice.co.uk, there are many different types of debt factoring facilities, but in general they act as a prepayment, with the security being approved invoices (i.e., money coming into the company, but with a delay). Debt factoring, therefore, allows businesses to access payments that are delayed with a smaller cost of capital than waiting until the payments come in. When you’re dealing with cash flow, these can be vital.

3. Fixed Deposits

Fixed deposits are typically offered by banks, and they pay a better interest rate than your normal savings account might. The downside is that your deposit term is fixed. You are lending money to a bank with a predetermined time span - it can be as little as seven days or as long as a decade. You receive a pre-agreed rate of return, allowing you to invest in bull markets and keep earning even if there’s a financial crash. You will likely, however, receive a charge if you try to withdraw your money too soon, which can eat into your profits.

4. Mortgages

One of the most common forms of retail debt, mortgages are essentially a loan that is backed by some real estate. When people normally buy houses by using money that the bank has given them, they are actually buying the house on behalf of the bank. This is retail debt, and it is uncommon for companies to take out mortgages. A company will instead approach a bank looking for a loan, present their business plan and financial modelling and reduce the risk of their loan by offering land assets as collateral. In both the retail and corporate settings, banks will want to see evidence of income before issuing a loan, even if it is secured with physical assets like houses, offices, or factories.

Almost all the debt instruments listed here can be graded on the likelihood of the individual returning the investment.