Investors explore debt markets to grow wealth above inflation. Debt markets serve as investment mediums to match businesses seeking capital against creditors looking to make loans. Debt is critical for the functioning of the financial system.
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Businesses and governments issue debt securities to finance themselves. Creditors purchase these debt securities and are rewarded with interest payments, until the principal is repaid. Debt holders may own bonds, commercial paper or Treasury securities.
Debt securities pay either fixed, or variable interest rates. Fixed rates stay the same through loan maturity. Variable-rate loans regularly adjust interest payments according to prevailing rates.
Debt holders associate interest rates with risk levels. Safe, U.S. Government Treasuries pay low interest rates. Meanwhile, creditors typically demand higher interest rates from smaller corporations as compensation for increased risks.
Debt holders do not carry the ownership and voting rights associated with common stock. However, debt holders enjoy asset claims that are superior to shareholders. In the event of bankruptcy, debt holders are to be repaid first from liquidated assets.
Debt holders are exposed to systematic risks or financial system collapse. Credit crisis is a possibility, where banks refuse to make loans, and asset valuations fall because of default concerns.