Understanding Debt Securities: How Are These Financial Assets Beneficial for Investors?

Debt securities refer to financial assets that are bought or sold between two parties with basic terms defined. These financial instruments hold a promise from the issuer to pay the holder a specified amount at a particular date, which is when the debt security matures. They are negotiable assets which means their ownership can be transferred from one party to another easily. Government bonds, certificate of deposit, mortgage-backed securities, preferred stock, and municipal bonds are some of the popular examples of debt securities.   

How does debt security work? 

Debt securities are created when one party lends money to another. For instance, corporate bonds are types of financial instruments that are issued by corporations and sold to investors. Mostly investors return money to the organizations in return for a pre-established number of interest payments along with the return of their principal upon the bond’s maturity. Similarly, government bonds are issued by government bodies, which are sold to investors in return for interest payments and the bond’s maturity. These financial assets are known as fixed-income securities as they provide a fixed stream of income for their interest payments. In other financial instruments such as equity investments, the return earned by the investor completely relies on the market performance. However, debt securities ensure that investors receive payments of their principal amount along with a predetermined stream of interest payments.  

A look into the features of debt securities 

Various notable features of such financial instruments are there that investors must pay attention to. Debt securities include coupon rates that issuers need to pay. These coupon rates are fixed throughout the life of the security, or they vary depending on the inflation of the economy. In addition, these securities involve issue date which means the date at which the debt security was first issued. Further, the maturity date is the key feature of these financial assets, on which issuers need to repay the principal amount and remaining interest. It holds great importance in debt securities as the term length defines the price, interest rates, and benefits investors look for, such as higher returns with longer investments. In addition, yield-to-maturity is another aspect of these financial assets. It refers to the rate of return that investors expect to receive if the debt is stretched to maturity.  

Impairment of debt securities 

Impairment is a reduction in the value of an asset due to a decrease in its quantity, quality, or market value. Basically, it is an intricate accounting concept that means investors are accountable for any impairment losses on their companies’ profit or loss accounts. They usually compare the recoverable value of the asset with their book value before writing that amount as a loss. Therefore, the impairment of debt securities refers to the scenarios where the fair value of debt security is less than its amortized cost basis.  

Are debt securities a beneficial investment? 

Many benefits are associated with these financial assets. Basically, they are designed to provide investors with repayment of their initial capital investment. These fixed-income streams are an attractive alternative for investors who prefer a steady cash flow, especially after retirement or during uncertain economic conditions. Moreover, they are considered safer than equities, offering a higher degree of security compared to stocks due to their priority in claims during bankruptcy. In addition, these financial instruments offer extensive portfolio diversification by effectively reducing overall risk and stabilizing returns during market volatility. They act as a shield against the fluctuations of equity markets, providing a balance that enhances the overall performance of an investment strategy. 

Risks associated with debt securities  

Though debt securities are less volatile than stocks, they still possess some risks. As the borrower is legally required to make these payments, debt securities are considered to be a less risky form of investment compared to other equity investments such as stocks. For instance, a company with a strong balance sheet operating in a mature marketplace is less likely to become a defaulter than a startup company functioning in an evolving marketplace. Moreover, companies with higher credit ratings usually offer lower interest rates on their debt securities while keeping with the general tradeoff between risk and return.  

What is the main difference between debt securities and equity securities? 

Mainly, equity security represents a claim on the earnings and assets of a corporation, however, debt securities are the loans given by investors. For instance, stock is an equity security, however, bond is a debt security. When investors purchase a corporate bond, they are essentially loaning the corporation money and have the right to repay the principal & interest on the bond. On the other hand, when someone buys stock from a corporation, they essentially buy a piece of the company. However, if the company gains profits, the investor receives profits as well. At the same time if the company loses money, the stock also loses money. Such promising benefits of these financial assets are expected to boost the growth of the debt security market in the coming years. According to Allied Market Research, the industry is anticipated to rise at a CAGR of 7.8% from 2023 to 2032. 

SEBI’s new liquidity window facility 

In October 2024, the Securities and Exchange Bureau of India (SEBI) launched a new facility that is designed to enhance liquidity for investors in debt securities. The initiative allows investors to sell their bonds back to the issuer before the maturity date, improving the liquidity and flexibility of corporate bonds. SEBI aims to create a more dynamic and investor-friendly corporate bond market by offering a clear and standardized framework for implementing this facility.  

Key features of the new facility 

The liquidity window facility is an optional feature that debt security issuers choose to offer at the time of issuance. This flexibility enables issuers to tailor the facility to their specific needs and market conditions. The facility is designed to be available for all investors or retail investors to hold their debt securities in dematerialized form. Moreover, issuers have the flexibility to set a maximum limit for the total amount of debt securities that are redeemed through the liquidity window. This limit is set at 10% or more of the total issue size. In addition, issuers impose sub-limits for each liquidity window session to manage redemption flows effectively. Furthermore, issuers are able to maintain transparency by disclosing detailed information through the liquidity window, including the schedule, redemption activities, and outstanding amounts. Moreover, issuers designate a specific stock exchange to operate the liquidity window. This exchange is responsible for facilitating the redemption process and ensuring transparency. The new facility is typically open for three working days on a monthly or quarterly basis.  

Who is expected to benefit from this facility? 

This facility is especially beneficial for retail investors who do not have easy access to secondary markets for selling their debt securities. It offers a guaranteed exit option, improving liquidity and minimizing investment risks. Moreover, institutional investors have more flexibility in managing their portfolios, this facility is useful for tactical portfolio adjustments to meet specific liquidity needs. In addition, brokers and dealers benefit from this facility, enabling them to adapt their systems and processes to facilitate the trading and settlement of debt securities under the modern liquidity window framework.  

Final words 

Debt securities are profitable financial instruments that investors mainly purchase to get significant returns. They offer a safer option for investors to make investments and offer them greater flexibility to diversify their portfolios. Moreover, rise in integration of modern technologies such as blockchain, electronic trading, and algorithm trading is expected to increase the liquidity of the industry in the coming period.   

✍ **𝑨𝒓𝒕𝒊𝒄𝒍𝒆 𝒘𝒓𝒊𝒕𝒆𝒓: Rosy Behera 

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