What is a Debt Security?
A debt security is any type of debt instrument that can be purchased or sold, and that carries some type of maturity date and a rate of interest that is applied to the balance of the debt. Sometimes referred to as a fixed-rate security, a debt security is normally bought and sold over the counter. Securities of this type are often held and traded by larger institutions, as well as a number of non-profit organizations and even government agencies.
One of the best examples of a debt security is the bank certificate of deposit. Financial instruments such as bank CDs are considered debt instruments, in that the bank customer is lending his or her money to the institution for a specified period of time. In exchange for the loan, the bank applies a certain amount of interest to the balance of the deposit, with all the interest credited to the owner of the CD at or before the date of maturity.
Government and corporate bonds are also excellent examples of debt securities. With a bond issue, the lender invests a certain amount of money, and can expect to recoup both that original investment plus some type of return once the issue reaches full maturity. In the interim, the debtor has the use of the funds received from the bond issue, making it possible to fund projects that eventually become profitable and generate revenue that allows the debtor to repay the loan, along with the applicable interest.
Even something as simple as an IOU or a promissory note can be considered a debt security. As long as there is a specific date in which the loan is to be repaid in full, and there is some sort of interest that is paid along with the full amount of the original loan, it qualifies as this type of security. While these forms of debt instruments are used less frequently today than in times past, they do still represent a situation in which a lender is assuming some degree of risk, and is charging interest based on the perceived ability of the debtor to repay the loan.
This instrument is generally considered to carry less risk than most types of equity securities. This is because the face value of the loan is not subject to change, based on shifts in the economy. While there are some instances where the rate of interest applied is variable rather than fixed, the necessity of repaying the amount of the original investment remains the same.
Whatever kind of debt security is used, there is always some risk to the lender. The ones with the most risk are the I.O.Us or promissory notes. Even if there is a clear agreement between lender and borrower about how much the loan is, how percent interest will be paid, and when the note will become due, it's still risky for the lender, if the borrower doesn't have enough to pay the loan back, or just refuses to.
Many friendship and relationships have been broken because of unpaid promissory notes.It's probably better not to lend anyone money. It might be wiser to just give a family member some money, and hope that they will find some non-monetary way to repay you.
@MrMoody - I’d go with the corporate bonds. You will get a higher rate of return, although there will be substantial risk.
The corporations can go into default. But seriously, how often does that happen? It depends on what corporation you are investing in. If you buy bonds for some Internet startup, the risks of default are quite high.
If you go with the bellwether blue chips that have been around for fifty years or so, I don’t think you can go wrong.
I can’t believe that banks advertise CD rates at 1.10% and expect me to jump up and down and get all excited about it. That barely edges out inflation.
It certainly beats putting your money in stocks and seeing your money disappear if the stock tanks, but that’s not likely to happen if you are smart and diversify your portfolio.
In any rate if you want a conservative invesement I think you are better off investing in a municipal bond for a city or state government. They have very low rates of default because they are backed by public treasuries, yet they should give you better returns than you would get with a CD.
Debt security is a little confusing, but I do understand certificates of deposit. I have bought a fair number of these and have some now. But the banks aren't paying nearly as much interest as they did before the economic downturn. But the interest rate is, at least, better than in a bank savings account.
CDs used to be a safe and fairly profitable way of making your money grow. Usually the longer term ones, say five to ten years earn a pretty decent interest rate.
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