Philippine Christian University

College of Business Administration and Accountancy

CAPITAL MARKETS
Lesson Topics: April 26, 2021
DEBT INSTRUMENTS

Read Reference “Links” and Watch Videos (*)

References:
https://www.investopedia.com/terms/d/debtinstrument.asp
https://corporatefinanceinstitute.com/resources/knowledge/credit/debt-instrument/
https://www.wallstreetmojo.com/debt-instruments/

DEBT*

Debt is a financial transaction, where money is borrowed by one party (borrower or obligor)
from another (lender or creditor*)  .

 Debt is used by many corporations and individuals to make large purchases that they
could not afford under normal circumstances.
 A debt arrangement gives the borrowing party permission to borrow money under
specific loan terms and conditions including (but not limited to) that the loan principal is
to be repaid at an agreed future maturity date*, usually with interest*.
 Debt can be classified into four main categories:

o secured debt
o unsecured debt
o revolving loans
o term loans (example: mortgage* loans are secured term loans)

 The interest rate for a Debt may computed by:

o fixed rate payment (fixed interest rate)

o floating interestr ate (variable interest rate)
o discounted interest rate

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 Philippine Christian University
College of Business Administration and Accountancy

DEBT FINANCING*

There are two methods by which a company can raise money for working capital* to finance
day to day business operations or for capital expenditure* required for upgrading, growth and
expansion of the company – are:

 Equity financing* is the process of raising capital through the issue of shares of stock in
a public offering. Investors in equity securities are called “shareholders*” i.e. part
owners of the company

 Debt Financing* occurs when the company sells Debt Instruments* to individuals
and/or institutional investors to raise capital*.

DEBT INSTRUMENTS*

A debt instrument is a tool that 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 loan provisions on the deal such
as collateral involved, the rate of interest*, the
 amortization schedule, for interest and principal payments, and the timeframe to
maturity*, if applicable.
 Businesses have flexibility in the debt instruments they use and also how they choose to
structure them.

TYPES OF DEBT INSTRUMENTS

The types of debt instruments are categorized as follows:

 Long-Term
 Medium- term and
 Short-term

#1 – Long-Term Debt Instruments (LTDI)

The company uses LTDI for its growth, heavy investments, future planning. These instruments
generally have a period of financing of more than 5 years. These instruments have a charge on
the company’s assets and also bears an interest paid regularly.

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 Philippine Christian University
College of Business Administration and Accountancy

#A – Debentures*

A debenture is the most used and most accepted source of long-term financing by a
company. These carry a fixed Interest Rate on the finance raised by the company
through this mode of the debt instrument. These are raised for a minimum period of 5
years. Debenture forms part of the capital structure of the company but is not clubbed
with calculating share capital in the balance sheet.

#B – Bonds

Bonds are similar to debentures, but the main difference is that bonds are used by the
government, central bank & large companies, and also these are backed by securities,
which means these have a charge over the company’s assets. These also have a fixed
interest rate which are normally based on the issuers’ credit rating, and the tenor is also
at least 5 years.

 Corporate Bonds are a type of debt security that is issued by a firm and sold to
investors. The company gets the capital it needs and in return the investor is
paid a pre-established number of interest payments at either a fixed or variable
interest rate. When the bond expires, or "reaches maturity," the payments cease
and the original investment is returned.

 Ttreasury Bonds* are government debt securities issued by the U.S. Federal

government that have maturities greater than 20 years. T-bonds earn periodic
interest until maturity, at which point the owner is also paid a par amount equal
to the principal.

#C – Long-Term Loans

Companies use LT Loans to obtain financing from financial institutions (including banks).
This is a less preferred option of financing since this financing method is usually secured
(by mortgage of assets) and the Interest rates are higher compared to Debentures.

#D – Mortgage loans

Under this option, the company can raise funds by mortgaging their assets with other
entities i.e., other companies, individuals, banks, financial institutions, etc. These types
of loans may have a higher rate of interest.

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 Philippine Christian University
College of Business Administration and Accountancy

#2 – Medium & Short-Term Debt Instruments

These types of debt instruments are generally used by the companies to finance day to day working
capital requirements. The period of financing in periods are generally up to 5 years for Medium term
and one year or less for Short term facilities. Such facilities are normally unsecured by the company’s
assets and also don’t have a high-interest liability on the companies. Examples are as follows: -

#A – Working Capital Loans*

Working capital loans are the loans that are used by the companies to finance their day to day
business and operational activities like servicing of suppliers and creditors, payment for rent and
utilities, purchase of raw material and supplies, repairs of PPE. These credit facilities are
normally revolving in nature which allows the company flexibility in utilization based on working
capital and cash flow gaps. Interest charges are based on actual outstanding utilization and not
credit limit amount.

#B – Short-Term Loans

Short term loans are granted by Banks and financial institution based on the company’s financial
requirements supported by projected cash flow of its operations. The period of loans are tailor
made to enable settlement when free cash flow is generated by the company’s business
operations.

#c – Ttreasury Bills*

Treasury Bills are short-term debt instruments that mature within 12 months. They are
redeemed at the maturity in full, and if sold before maturity, then they can be sold at a
discounted price. The interest on these T-bills is covered in the issue price as they issued at a
premium and redeemed at par value.

#D - Treasury Notes

A Treasury note (T-note for short) is a marketable U.S. government debt security with a

fixed interest rate and a maturity between one and 10 years.

#E - Ppromissory Notes*

A Promissory Notes is a financial instrument that contains a written promise by one

party (the note's issuer or maker) to pay another party (the note's payee) a definite sum
of money, either on demand or at a specified future date. A promissory note typically
contains all the terms pertaining to the indebtedness, such as the principal amount,
interest rate, maturity date, date and place of issuance, and issuer's signature.

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 Philippine Christian University
College of Business Administration and Accountancy

#F - Lease*

A lease is a contract outlining the terms under which one party agrees to rent property
owned by another party. It guarantees the lessee, also known as the tenant, use of an
asset and guarantees the lessor, the property owner or landlord, regular payments for a
specified period in exchange. Both the lessee and the lessor face consequences if they
fail to uphold the terms of the contract. It is a form of incorporeal right.

Advantages of Debt Instruments

 Access to Capital: Debt financing is popular among individuals, companies, and governments.
The issuer can raise capital from external sources to finance operations and enable growth and
expansion of the business subject to feasibility.

 Enhanced Profitability: If a company properly invests borrowed funds through debt

instruments, it can increase profitability. If the investment returns are greater than the interest
payments, the debtor will be able to generate profits on the debt financing.

 Maximizing Shareholder value: The process of financing through creditors to maximize

shareholder wealth is referred to as leverage.
In the field of private equity, companies make investments through leveraged buyouts that are
built around the investment to provide greater returns than the interest payments.

 
Disadvantages of Debt Instruments

Debt financing can be a great source of risk for businesses, primarily through increased liquidity risk and
solvency risk.

 Liquidity is hindered because interest payments are classified as a current liability and represent
a cash outflow within one year.
 Liquidity and solvency are important factors to consider, especially when assessing a company
based on the going-concern principle.

End of Presentation

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