malav soni
What are the differences between debt and equity markets? (October 2005)
First, some definitions
The debt market is the market where debt instruments are traded. Debt instruments are assets that require a fixed payment to the holder, usually with interest. Examples of debt instruments include bonds (government or corporate) and mortgages.
The equity market (often referred to as the stock market) is the market for trading equity instruments. Stocks are securities that are a claim on the earnings and assets of a corporation (Mishkin 1998). An example of an equity instrument would be common stock shares, such as those traded on the New York Stock Exchange.
How are debt instruments different from equity instruments?
There are important differences between stocks and bonds. Let me highlight several of them:
Equity financing allows a company to acquire funds (often for investment) without incurring debt. On the other hand, issuing a bond does increase the debt burden of the bond issuer because contractual interest payments must be paid— unlike dividends, they cannot be reduced or suspended.
Those who purchase equity instruments (stocks) gain ownership of the business whose shares they hold (in other words, they gain the right to vote on the issues important to the firm). In addition, equity holders have claims on the future earnings of the firm.
In contrast, bondholders do not gain ownership in the business or have any claims to the future profits of the borrower. The borrower’s only obligation is to repay the loan with interest.
Bonds are considered to be less risky investments for at least two reasons. First, bond market returns are less volatile than stock market returns. Se ...