DEBT

Securities
Debt
In order to raise capital, a firm may issue DEBT SECURITIES. Issuing debt securities is, in effect, taking out a loan, with the buyers of the security being the lenders. The issuer of a debt security is therefore obligated to pay the buyers of the security INTEREST according to a predetermined schedule, and to return the investment PRINCIPAL to the investor at a specified future date, known as MATURITY DATE. LONG TERM DEBT is debt with a maturity date of one year or more after issue date. SHORT TERM DEBT is debt with a maturity date of less than one year after issue.
In some instances, an issuer of long term debt may wish to repay all of the outstanding principal on a debt security prior to the scheduled maturity date, thereby retiring the debt. This is known as a CALL. Calls can be made on the entire issue, or on only a portion of the issue. The right of the issuer to do this will be clearly stated in the security's prospectus.
The amount of interest that is paid on a debt security is determined by the stated percentage rate on the debt instrument, which may be a fixed or a variable rate. This is also detailed in the prospectus, along with the number of times per year and the dates on which payments will be made.
The buyer of a firm's debt has purchased the right to receive income as scheduled. This is in contrast to the purchaser of a firm's equity securities, who receives income only if dividends are declared by the company. The advantage of equity is that the investor can benefit by future growth of the company for the life of the company; the disadvantage of equity is that income is not guaranteed, and the investor may lose a significant amount of value on the security. The advantage of debt, on the other hand, is that the investor takes less risk since interest payments are a legal obligation of the issuer and must be paid as scheduled.
One reason that a firm may want to issue debt instead of equity is that the financial obligations incurred by the firm are of a more specific nature. The firm has a definite amount of money in both principal and interest that is to be paid back at specific times. This helps in the financial planning process since the firm knows when they will need to have money on hand.
Sometimes a debt issuer DEFAULTS on an obligation by failing to pay the scheduled interest or maturity proceeds. In these cases, the owners of a firm's debt securities are among the first in line with a claim to any liquidation of the assets of the company. Shareholders, as owners, are last in line.
All new security issues must be registered with the Securities and Exchange Commission (SEC). Registration involves the filing of financial statements regarding the firm and other related information. A firm wishing to issue debt must qualify by possessing adequate financial status within established guidelines. Issuing debt places constraints on the firm; because the firm has an obligation to repay creditors, it must maintain the ability to meet these commitments.
A debt security is usually REGISTERED in the name of the owner. The registered holder's name will appear on the debt certificate and on the books of the paying agent. Registered holders receive the interest payments and any applicable corporate action notifications.
INTEREST accrues from the date of issuance, also referred to as the dated date, to the first payment date, or from one payment date to the next. Interest accrued is interest which is earned to date, but not yet paid. Accrued interest is traded along with the security when a debt instrument is bought and sold. The buyer pays the seller an amount equal to the interest accrued thus far in the payment period.
"PAR" is the term used for the principal value, or the face value of a debt instrument, and is the amount that will be paid to the holder at maturity. Debt can be sold either at, below, or above par value.
A security can be issued at a DISCOUNT (below par) when the interest is scheduled to be paid only at maturity. Full par value is paid to the holder at maturity; thus the difference between the purchase price and the maturity value represents the income earned on the security. This type of arrangement is common with money market instruments, which have short-term maturities. A zero-coupon bond is an example of a long-term debt security issued at a discount.
Securities can also sell at a discount from the current accrued value if market interest rates have increased since the security was issued. A security with a stated rate below market value is less attractive to investors; a discounted price will help to equalize the value of the security in the marketplace.
Securities selling at a PREMIUM carry a price higher than the current accrued value of the par. This can happen if market interest rates have fallen since the security was issued, making the security with the relatively higher rate more attractive to investors.
COLLATERAL is an asset, owned or controlled by a borrower, which is pledged to a lender in exchange for a loan. The value of the collateral is generally equivalent to that of the loan. The lender is given ownership or liquidation rights to the collateral in the event of default by the borrower, thereby giving the lender some protection against loss. Usually, some type of collateral is required in order to take out a loan, as a guarantee that the loan will be repaid. Debt securities are often backed by collateral pledged by the issuer. This collateral could consist of other securities, real estate, or some other asset which has a value comparable to that of the loan. When a security is collateralized, it is referred to as "secured". A security that does not have collateral behind it is "unsecured".
A security may be issued as a PRIVATE PLACEMENT. A private placement occurs when a firm sells securities directly to an investor, bypassing the securities market, underwriters, or any middlemen. Reasons why a security may be placed privately include that this method avoids the registration and disclosure process, and provides greater flexibility to negotiate terms with the buyer.