Investment markets can be categorized into two broad categories, Debt & Equity markets.
The debt market or bond market is the platform or field in which investments in loans are bought and sold. Here the transactions are held between brokers, large financial institutes, or individual investors.
The equity market is the platform or field in which stocks are bought and sold; some of these are BSE, NSE, MCX, NASDAQ, etc.
All about Debt Market
In the Debt markets, investments are in the form of bonds and debentures which are less risky but offer a low return on investment. Bondholders are the ones to be paid first even if a firm is being liquidated. Investments in the debt market are stable and do not fluctuate more in price than stocks.
Bonds are the most common type of investment in the debt market and have a fixed interest rate; these are issued by the companies or governments to raise the capital for their business purposes.
Example 1: When Company A needs capital for expansion; it applies for a secured business loan, which requires it to put up particular collateral. It has been approved for Rs. 25,000 loans with a five-year repayment period. The current interest rate is 7%. Company A will pay around Rs. 500 per month until the loan period ends, at which point it will have repaid the loan amount plus the interest amount.
Example 2: Company ABC decides to apply for a revolving business line of credit that is unsecured. A lender gives Company ABC Rs. 50,000 lines of credit at an interest rate of 8% in this debt financing example.
Types of Trades in the Debt Market:-
These can be issued by both the government and a firm. When one invests in bonds, they are effectively lending money to the bond issuer. The issuer then repays the loan, including interest, over a set period.
2> Government Securities or G-Secs
The Reserve Bank of India (RBI) issues these on behalf of the Indian government, available in both short and long terms. Treasury Bills (T-bills) are short-term bills with a maturity of less than one year, whereas Government Bonds or Dated Securities are long-term products.
A debenture is a debt instrument issued to the public by a firm. They can be secured or unsecured, and the principal is repaid over a set period.
4> Term Loans
Companies can get Term Loans from a bank which is a loan for a particular amount that has a defined repayment schedule and a fixed or floating interest rate.
All about Equity Market
A company’s ownership is represented by a share known as equity or stock. Dividends are the parts of a company’s profits that are distributed to its shareholders and can be profitable for the owner of an equity holding. If the market price of the stock increases, the equity holder profits from the selling of the stock.
The equity market is volatile by nature. Shares in the equity market can have large price movements that have less to do with the stability and reputation of the company that has issued them. Social, political, governmental, and economic developments all contribute to volatility. Therefore, a large financial industry exists to research, analyze, and forecast the direction of individual stocks, stock sectors, and equity markets.
Although the equity market has the potential to deliver greater returns on investment, it seems riskier. Before investing in the equity or debt market, you should seek a trusted financial advisor or take consultation from a reputable financial counselor.
Example 1: Ram is an entrepreneur and finds an investor willing to invest Rs. 100,000 in his firm, Company A, in exchange for a 10% stock stake. If no other investors are involved, this implies the investor will own 1/10 of Company A and the small business owner will own the remaining 90%. This also suggests the company is worth Rs. 1 million (Rs. 100,000 X 10).
Example 2: Ram has put Rs. 500,000 of his own money into his company, Company A, making him the sole owner. However, the moment arrives for Ram to expand his business; he can secure an Rs. 100,000 investment from a potential investor. The company now has a total capital of Rs. 600,000, which includes his initial personal investment of Rs. 500,000 and Rs. 100,000 in investor cash. Ram now owns 83.33% of the company [Rs. 500,000/ (Rs. 500,000 + Rs. 100,000)]. The remaining 16.67 percent is owned by the investor.
Types of Trades in the Equity Market:-
1> Intraday Trades
It is the trading of shares on the same day, also known as day trading. Here, all the positions are squared off before the market closes.
2> BTST (Buy Today, Sell Tomorrow)
As the name suggests, customers can sell shares before they are credited to a Demat account or before they are delivered. Within 2 days, the decision has to be taken. It is also known as Acquire Today, Sell Tomorrow (ATST).
3> Position Trades
It allows individual traders to keep a position open for a long time, like months or years. Short-term price movement is ignored by position traders, who prefer to concentrate on more detailed fundamental analysis and long-term trends.
Debt vs Equity Market: Pros and Cons
- Any firm of any size can use this service.
- Quick turnaround.
- Money can be used in a variety of ways.
- A wide range of financing levels is available.
- Determine the terms of repayment.
- Liability is restricted to the duration of the loan.
- Interest payments are tax-deductible
- It is possible to improve the business credit.
- Retain control
- A lender is not allowed to ask for a part of future profits.
- The lender has no control over the management of the company.
- No necessary shareholder meetings or investor reports.
- Some borrowers may not be able to fulfill the minimum credit score requirements.
- Financial outstanding may impact your borrowing limit, rates, and fees.
- Collateral is required.
- Debt service payments will swallow the profit margins.
- Repayment, including principal and interest, is necessary.
- Failure to repay the loan could result in the liquidation of the firm or assets.
- Taking on too much debt can lower a company’s value and make future funding difficult.
- Larger Amount of Capital Required.
- Investors are exposed to risk.
- There is no need for collateral.
- Revenues aren’t diverted to pay back the debt.
- On capital, no interest is necessary.
- Returns on investments should not be expected right away.
- Involved investors can function as corporate mentors
- If the firm fails, no repayment is expected.
- Releasing a portion of the company’s ownership
- Reduced independence
- Investors can have an impact on corporate culture and decisions.
- Pitching investors is very time-consuming and problematic.
- The approval procedure can take too long.
- A detailed business plan is required by potential investors.
- The time it takes to receive funds is longer.
- Your profit share may be reduced if you own a smaller percentage of the company.
- Investors have the power to compel original owners to sell.
Ways to Invest in Equity Market and Debt Market
Two ways you can access the Equity Market:-
- Direct Investment: You can buy individual stocks listed on stock exchanges to invest in equities directly. This strategy necessitates greater investigation into the specific company you wish to invest in. You must first choose which industry best fits your investment profile, after which you must select the best-performing companies with a solid growth trajectory.
- Mutual Funds: You can put your money into mutual funds that combine money from all investors and invest it in shares. You will not be directly involved in investment decisions in this environment. An investor can hire a fund manager to mentor which stocks to buy and which not.
- Direct Investment – In the case of corporate bonds, you can invest in them through a private placement directly with the company. When it comes to government bonds, the RBI, which oversees the selling of these bonds, holds auctions. You can join in these auctions in one of two ways:
- Competitive Bidding – The process is complicated therefore the big investors like mutual fund companies, banks, commercial firms, etc, participate via competitive bidding.
- Non-Competitive Bidding – Non-Competitive Bidding can be processed through online platforms. National Stock Exchange (NSE) has an app called NSE goBid, where other smaller investors can invest in government securities directly. It is an easy process for individual investors, like as those that have high net worth individuals (HNI), retail investors, etc.
- Mutual Funds – This is a detour route. Regardless of whether they are debt or equity funds, the mutual fund business operates similarly. A fund manager will be in charge of deciding which government securities to invest in. Debt or hybrid mutual funds are a shady technique to keep your money in the debt markets.
17 Key differences between Equity and Debt:-
|Equity is owned capital.
|Debit is borrowed capital.
|Nature of Investment
|You invest in markets.
|You invest in loans.
|Who can issue
|Companies registered with SEBI.
|Government Securities (G-Secs), Debentures
|Shareholders, part owners in the company.
|Creditors to the company/government.
|Riskier, More Market Exposure.
|Less Risky because government-backed, however, corporate bonds are risky; Less Market Exposure.
|Potential for High Growth
|Good for capital preservation
|Sources of Earning
|Company’s growth, Dividends
|Interest paid by the bond issuer.
|Highly Volatile, Trading Intensive
|Relatively Stable, Not as Trading Intensive
|RBI and SEBI in case of corporate bonds
|Timing of equities’ buy-sell is very important as the stock market is quite active and may be very volatile at times.
|The timing of buy-sell is not that important. In debt funds, the duration of the investment is more crucial.
|The equity fund expense ratio is much higher if you compare equity with debt funds.
|The expense ratio of a debt fund is much lower compared to equity funds.
|Capital gains from equity funds held for less than a year are taxed at a rate of 15%. Long-term capital gains (over 12 months) are tax-free up to Rs 1 lakh, after which they are taxed at 10%.
|Debt funds held for less than 36 months are taxed at the investor’s marginal tax rate. After allowing for indexation benefits, long-term capital gains (greater than 36 months) are taxed at 20%.
|Equity securities do not have a Maturity Date.
|Debt Securities have a Maturity Date.
|Equity Portfolio has a higher turnover rate. The debt portfolio has a low turnover rate as compared with the equity portfolio.
|Lower return as compared to equity.
|The equity market generates long-term returns.
|The debt Market generates short-term returns.
|Successful investment in the Equity Market involves a greater deal of research and follow-ups.
|Not much research is required to invest in the debt market.
Debt vs Equity: Which market is larger?
The debt market is linked with low risk when compared to the equity market. The debt market provides a consistent source of income and capital preservation, although its returns are typically lower than those of the equity market. You buy and sell shares on the stock exchange.
How to Decide Which Is Best for Your Business Debt or Equity?
Choosing one between equity and debt depends on your needs and financial goals. However, choosing the debt market over the equity market is a good decision because, in the equity market, you give most of the control to other investors by involving them in the company and making complicated future decision-making. On the other hand, debt is a very short-term strategy that keeps you in control of your company as long as you can pay off the debt and interest in full.
However, participation in the equity or debt markets, from the perspective of an investor, is determined by risk appetite, investment objective, time horizon, and other factors. Regardless of whose party you belong to, you should make your decision after consulting professionals who can give you up-to-date market knowledge.