Debt Instruments


A contractual arrangement in which the issuer agrees to pay interest and repay the borrowed amount after a specified period of time is a debt instrument. Certain features common to all debt instruments are:
Maturity – the number of years over which the issuer agrees to meet the contractual obligations is the term to maturity. Debt instruments are classified on the basis of the time remaining to maturity
 Par value – the face value or principal value of the debt instrument is called the par value.
Coupon rate – agreed rate of interest that is paid periodically to the investor and is calculated as a percentage of the face value. Some of the debt instruments may not have an explicit coupon rate, for instance zero coupon bonds. These bonds are issued on discount and redeemed at par. Thus the difference between the investor’s investment and return is the interest earned. Coupon rates may be fixed for the term or may be variable.
Call option – option available to the issuer, specified in the trust indenture, to ‘call in’ the bonds and repay them at pre determined price before maturity. Call feature acts like a ceiling f or payments. The issuer may call the bonds before the stated maturity as it may recognize that the interest rates may fall below the coupon rate and redeeming the bonds and replacing them with securities of lower coupon rates will be economically beneficial. It is the same as the prepayment option, where the borrower prepays before scheduled payments or slated maturity.
Some bonds are issued with ‘call protection feature, i.e they would not be called for a specified period of time .
Similar to the call option of the issuer there is a put option for the investor, to sell the securities back to the issuer at a predetermined price and date. The investor may do so anticipating rise in the interest rates wherein the investor would liquidate the funds and alternatively invest in place of higher interest.
 Refunding provisions – in case where the issuer may not have cash to redeem the debt instruments the issuer may issue new debt instrument and use the proceeds to repay the securities or to exercise the call option.

Friday, 02nd Oct 2015, 09:06:22 AM

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