Debt Instrument

What Is a Debt Instrument?

A debt instrument is a tool an entity can utilize to raise capital. It is a documented, binding obligation that provides funds to an entity in return for a promise from the entity to repay a lender or investor in accordance with terms of a contract. Debt instrument contracts include detailed provisions on the deal such as collateral involved, the rate of interest, the schedule for interest payments, and the timeframe to maturity if applicable.

Understanding Debt Instruments

Any type of instrument primarily classified as debt can be considered a debt instrument. Debt instruments are tools an individual, government entity, or business entity can utilize for the purpose of obtaining capital. Debt instruments provide capital to an entity that promises to repay the capital over time. Credit cards, credit lines, loans, and bonds can all be types of debt instruments.

Typically, the term debt instrument primarily focuses on debt capital raised by institutional entities. Institutional entities can include governments and both private and public companies. For financial business accounting purposes, the Financial Accounting Standards Board’s Generally Accepted Accounting Principles (GAAP) and the International Accounting Standards Board’s International Financial Reporting Standards (IFRS) may have certain requirements for the reporting of different types of debt instruments on an entity’s financial statements.

The issuance markets for institutionalized entities varies substantially by the type of debt instrument. Credit cards and credit lines are a type of debt instrument an institution can use to obtain capital. These revolving debt lines usually have simple structuring and only a single lender. They are also not typically associated with a primary or secondary market for securitization. More complex debt instruments will involve advanced contract structuring and the involvement of multiple lenders or investors, usually investing through an organized marketplace.

Instrument Structuring and Types

Debt is typically a top choice for institutional capital raising because it comes with a defined schedule for repayment and thus lower risk which allows for lower interest payments. Debt securities are a more complex type of debt instrument that involves more extensive structuring. If an institutional entity chooses to structure debt in order to obtain capital from multiple lenders or investors through an organized marketplace it is usually characterized as a debt security instrument. Debt security instruments are complex, advanced debt instruments structured for issuance to multiple investors.

Some of the most common debt security instruments include:

Entities issue these debt security instruments because the issuance structuring allows for capital to be obtained from multiple investors. Debt securities can be structured with either short-term or long-term maturities. Short-term debt securities are paid back to investors and closed within one year. Long-term debt securities require payments to investors for more than one year. Entities typically structure debt security offerings for repayments ranging from one month to 30 years.

Below is a breakdown of some of the most common debt security instruments used by entities to raise capital.

U.S. Treasuries

U.S. Treasuries come in many forms denoted across the U.S. Treasury yield curve. The U.S. Treasury issues debt security instruments with one-month, two-month, three-month, six-month, one-year, two-year, three-year, five-year, seven-year, 10-year, 20-year, and 30-year maturities. Each of these offerings is a debt security instrument offered by the U.S. government to the entire public for the purpose of raising capital to fund the government.

Municipal Bonds

Municipal bonds are a type of debt security instrument issued by agencies of the U.S. government for the purpose of funding infrastructure projects. Municipal bond security investors are primarily institutional investors such as mutual funds.

Corporate Bonds

Corporate bonds are a type of debt security an entity can structure to raise capital from the entire investing public. Institutional mutual fund investors are usually some of the most prominent corporate bond investors but individuals with brokerage access may also have the opportunity to invest in corporate bond issuance as well. Corporate bonds also have an active secondary market which is utilized by both individual and institutional investors.

Companies structure corporate bonds with different maturities. The maturity structuring of a corporate bond is an influencing factor in the interest rate offered by the bond.

Alternative Structured Debt Security Products

There are also a variety of alternative structured debt security products in the market, primarily used as debt security instruments by financial institutions. These offerings include a bundle of assets issued as a debt security.

Financial institutions or financial agencies may choose to bundle products from their balance sheet into a single debt security instrument offering. As a security instrument, the offering raises capital for the institution while also segregating the bundled assets.