Or “rendering what is fixed, volatile, and what is volatile, fixed”
A debt security is a financial instrument representing the borrower's obligation to the lender from whom he has received funds. This obligation provides for a schedule of cash flows defining the terms of repayment of the funds and the lender's remuneration in the interval. The remuneration may be fixed during the life of the debt or floating if it is linked to a benchmark or index.
The reader should recognise the basic differences between debt (Chapters 21 and 22) and equity (Chapter 23).
- has a remuneration which is independent of the company's results and is contractually set in advance. Except in some extreme cases (a missed payment or bankruptcy), the lender will receive the interest due to him regardless of whether the company's results are excellent, average or poor;
- always has a repayment date, however far off, that is also set contractually. For the moment, we will set aside the rare case of perpetual debt;
- is paid off ahead of equity when the company is liquidated and its assets sold off. The proceeds will first be used to pay off creditors, and only when they have been fully repaid will any surplus be paid to shareholders.
- has a remuneration which depends on company earnings. If those earnings are bad, there is no dividend or capital gain;
- carries no guarantee of repayment at any date, however far into the future. The only “way out” for an equity investor is to sell ...