What are Debt Investments?
• A debt investment, is the process of investing in someone or something’s (corporation or government entity) debt schedule; the owner of a debt security, in essence, is betting that the issuer of the debt instrument is going to pay-off, in full, the underlying debt obligation.
• Debt investments are loans given to individuals or companies to finance property or projects. When the loan is given, the borrower is required to pay you back, typically with interest. If the property or project is pledged as collateral for the money borrowed, the lender may reclaim the collateral if a default is realized.
• Debt investing requires betting against or with the financing of someone’s property or other endeavor. The process is initiated when the investor loans funds to a corporation or individual for the purchase of something; when the borrower makes payments it is kicked back, with interest, to the lender. Now, debt investments are typically packaged together and sold in bundles so it is
• Debt investments typically involve the exchange of a debt security, such as, bonds, collateralized debt obligation (CDOs) or collateralized mortgage obligations (CMOs).
Debt Investment Process:
• In a general sense, the debt investment process works through an initial purchase of bonds or debt obligations. Bonds, in essence, are promissory notes that are purchased at face value. The bond package will indicate that the investor reached an agreement with the issuing entity in which he or she is investing with. When purchased, the bonds signify that the issuing agency has a debt with you.
• When the bond reaches its maturity date (will take at least six months), the investor may redeem it or cash it in. At this time, the issuing company will pay you the face value (the amount you paid into it) of the bond or debt, plus all interest earned.
What are the Benefits of Debt Investments?
• Investing in debt, in most instances, is a prudent means to receive fixed income. The risk aversion stems from the fact that bonds are backed by the issuing organization; if the bond goes into default the organization will receive a poor credit or bond rating. Additionally, even if the bond defaults, an investor can obtain a profit by seizing the company’s assets. The obtainment of debt investments also enables the holder of the debt to accurately predict, because of the coupon attached, their expected payments or profits.
• That being said, the level of risk is associated with the underlying debt investment’s rating. Those that are rated lower are more likely to default and vice versa.
• In addition to being relatively safe, debt investments provide a form of insurance or leverage for higher risk investments in an individual’s portfolio.
Drawbacks to Debt Investments:
• Purchasing debt investments requires the investor to go through a broker dealer or investment bank; this requirement will invariably mandate the inclusion of broker fees. Furthermore, all debt investments come with the risk of the issuing corporation or agency defaulting; however this risk is made tangible through the issuance of bond ratings.
• Debt investments also do not provide immediate returns. This illiquid feature disables the investor from withdrawing cash from his or her investment.