Debt Market vs. Equity Market: An Overview
Debt market and equity market are broad terms for two categories of investment that are bought and sold.
The debt market, or bond market, is the arena in which investment in loans are bought and sold. There is no single physical exchange for bonds. Transactions are mostly made between brokers or large institutions, or by individual investors.
The equity market, or the stock market, is the arena in which stocks are bought and sold. The term encompasses all of the marketplaces such as the New York Stock Exchange (NYSE), the Nasdaq, and the London Stock Exchange (LSE), and many others.
- In the equity market, investors and traders buy and sell shares of stock.
- Stocks are stakes in a company, purchased to profit from company dividends or the resale of the stock.
- In the debt market, investors and traders buy and sell bonds.
- Debt instruments are essentially loans that yield payments of interest to their owners.
- Equities are inherently riskier than debt and have a greater potential for big gains or big losses.
The equity market is viewed as inherently risky while having the potential to deliver a higher return than other investments.
Investments in debt securities typically involve less risk than equity investments and offer a lower potential return on investment. Debt investments by nature fluctuate less in price than stocks. Even if a company is liquidated, bondholders are the first to be paid.
Bonds are the most common form of debt investment. These are issued by corporations or by the government to raise capital for their operations and generally carry a fixed interest rate. Most are unsecured but are issued with a rating by one of several agencies such as Moody's to indicate the likely integrity of the issuer.
Risky Real Estate and Mortgage-Backed Debt
Real estate and mortgage debt investments are other large categories of debt instruments. Here, the underlying asset securing the debt is real estate know as the collateral. Many real estate- and mortgage-backed debt securities are complex in nature and require the investor to be knowledgeable of their risks.
The Changing Value of Fixed-Rate Bonds
It is reasonable to ask why a fixed-rate investment can change in value. If an individual investor buys a bond, it will pay a set amount of interest periodically until it matures, and then can be redeemed at face value. However, that bond might be resold in the debt market, called the secondary market.
The bond retains its face value at maturity. However, its real yield, or net profit, to a buyer change constantly. It loses yield by the amount that has already been paid in interest. The investment value increases or decreases with the constant fluctuations in the going interest prices offered by newly-issued bonds. If the interest rate of return on the bond is higher than the going rate, and the bond a reasonable time until maturity, the value may be at par or above the face value.
Thus, in the secondary market, the bond will sell at a discount to its face value or a premium to its face value.
Equity, or stock, represents a share of ownership of a company. The owner of an equity stake may profit from dividends. Dividends are the percentage of company profits returned to shareholders. The equity holder may also profit from the sale of the stock if the market price should increase in the marketplace.
The owner of an equity stake can also lose money. In the case of bankruptcy, they may lose the entire stake.
The equity market is volatile by nature. Shares of equity can experience substantial price swings, sometimes having little to do with the stability and good name of the corporation that issued them.
Volatility can be caused by social, political, governmental, or economic events. A large financial industry exists to research, analyze, and predict the direction of individual stocks, stock sectors, and the equity market in general.
The equity market is viewed as inherently risky while having the potential to deliver a higher return than other investments. One of the best things an investor in either equity or debt can do is to educate themselves and speak to a trusted financial advisor.