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First, Some Definitions

The document discusses the differences between debt and equity markets. It defines the debt market as where debt instruments like bonds and mortgages are traded, while the equity market trades equity instruments like common stocks. It outlines three key differences: equity financing does not incur debt for a company; equity holders gain ownership and claims on profits, while bondholders do not; and bonds are less risky than stocks since bondholders are paid before other expenses if a company runs into trouble.

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Ashish Malap
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18 views

First, Some Definitions

The document discusses the differences between debt and equity markets. It defines the debt market as where debt instruments like bonds and mortgages are traded, while the equity market trades equity instruments like common stocks. It outlines three key differences: equity financing does not incur debt for a company; equity holders gain ownership and claims on profits, while bondholders do not; and bonds are less risky than stocks since bondholders are paid before other expenses if a company runs into trouble.

Uploaded by

Ashish Malap
Copyright
© © All Rights Reserved
Available Formats
Download as DOCX, PDF, TXT or read online on Scribd
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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:

1. 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.

2. 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 borrowers
only obligation is to repay the loan with interest.

3. Bonds are considered to be less risky investments for at least


two reasons. First, bond market returns are less volatile than stock
market returns. Second, should the company run into trouble,
bondholders are paid first, before other expenses are paid.
Shareholders are less likely to receive any compensation in this
scenario.

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