Debt Issue
A Debt Issue is a financial obligation that allows the issuer to rain funds by promising the issuer to repay the lender at a certain point in the future which will be in accordance with the term of the contract. A debt issue is a fixed corporate or government obligation such as a bond or a debenture. These also include notes, certificates, mortgages, leases, or other agreements between the issuer or borrower, and the lender.
Book your CFA Demo Session Click Here
When a company or government agency decides to take out a loan, it can either get financing from a bank or issue debt to investors in the capital markets. This is known as a debt issue—the issuance of a debt instrument by an entity in need of capital to fund new or existing projects or to finance existing debt. This method of raising capital may be preferred, as compared to securing a loan from a bank because it restricts how the funds can be used.
A debt issue is essentially a promissory note in which the issuer is the borrower, and the entity buying the debt asset as the lender. When a debt issue is made available, investors buy it from the seller who uses the funds to pursue its capital projects. In return, the investor is promised regular interest payments and also repayment of the invested principal on a predetermined date in the future.
Process:
Corporate Debt Issuance:
Corporate debt issued by the company should be approved by the board of directors. They draft a proposal that is sent to investment bankers and underwriters if debt issuance is the best course of action for raising capital and the firm has sufficient cash flows to make regular interest payments on the issue. Corporate debt issues are commonly issued through underwriting. The interest rate that is set on the bonds is based on the credit rating of the company along with the demand from investors. The underwriters charge a fee on the issuer in return for their services.
Government Debt Issuance:
The process for government debt issues is different since these are mostly issued in an auction format. For example, in the United States, investors can purchase bonds directly from the government through a website, Treasury Direct dedicated for the purpose. A broker is not needed, and all transactions, are handled electronically. Debt issued by the government is considered to be a safe investment since it is backed by the full faith and credit of the government. Interest rates on government issues tend to be lower than rates on corporate bonds since investors are guaranteed they will receive a certain interest rate and face value on the bond.
Book your FRM Demo Session Click Here
Cost of Debts:
The cost of debt represents the default risk of an issuer and the level of interest rates in the market. The interest rate paid on a debt instrument represents a cost paid to the issuer and a return to the investor. It is useful in calculating the weighted-average cost of capital (WACC) of a company, which is a measure of the cost of equity and the after-tax cost of debt.
Conclusion
A debt issue is a fixed loan repayment obligation issued by organizations and the government for internal uses and funding. It includes a contractual obligation to pay the lender a certain interest rate, as well as to pay back the amount of the original loan by a fixed date.
Author: Mahek Medh
About the Author: Currently, I am in my second-year bachelor’s program and over the period of time I have realized that I enjoy learning about numbers and money, and I find topics of Finance to very interesting thus this is the domain and space where I wish to etch my long term career.
Related:
