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What Are Debt Securities and How Do They Work?

In Short: A debt security is a financial instrument issued by an entity and sold to an investor. The security has a loan as its underlying asset and it represents an obligation for the investor to be paid back the face value plus interest income as the instrument matures. The most common type of debt security are bonds such as corporate bonds or government bonds.

When you invest in a bond, you’re not just investing in a financial instrument. You’re making an investment that helps an entity raise money. This is why bonds, along with several other types of investments, are called “debt securities.”

What Are Debt Securities?

Debt securities are exactly what they sound like: investable assets used to raise debt for an entity. Individual investors, institutional investors, and even governments can purchase with the potential (but never the outright guarantee) of returning their principal with interest. They exist in tandem with the equities (stock) market, though are significantly larger in size and scope.

Debt securities help companies gain access to capital for expansion, or governments access to funds for various purposes. For instance, a company could issue a corporate bond if they were looking to increase their production capacity but needed the funds to do so. In a famous example of government bonds, the United States issued Series E bonds during World War II by the U.S. Government were created to help directly fund military efforts.

There are many different types of debt securities, but corporate bonds and government bonds are perhaps the most common. Municipal bonds, preferred stock, certificates of deposit (CDs), and mortgage-backed securities are also considered debt securities.

What Are the Risks?

With every debt security issued, there’s always the risk that the entity borrowing money does not pay back the amount borrowed and/or the interest. While there are ways to recoup some or all of the owed capital through legal proceedings, they take time, cost even more to take action, and are never guaranteed.

To prepare investors for any or all risks involved with investing in some debt securities, agencies like S&P and Moody’s will often issue ratings to entities involved in issuing these securities. These ratings indicate how likely an entity is to pay back their debt. Bonds with higher ratings often have lower interest rates attached, and those with lower ratings are often considered riskier.

Private debt securities like those featured on Percent and other alternative investment platforms are first assessed for risk by due diligence teams before they’re open to investments. These teams assess the borrowers’ debt histories, their capabilities for paying back the debt with interest, and innumerable other factors. Should a debt security and the companies involved not meet the requirements set by due diligence teams and their platforms, the platforms would opt to not make that security available for investment.

Like all investments, due diligence, credit ratings, and other publicly available information should help inform each investor’s calculated decision on whether or not to invest. They do not, however, serve as foolproof predictions as to whether or not a debt security investment will be paid back in full, or at all.

What Are Debt Securities on Percent?

Percent allows accredited investors to invest in private debt securities. By working with private companies (borrowers in need of capital), Percent offers investors the opportunity to invest in exclusive short-term debt deals. When these private companies pay back their obligations, investors receive their principal investment with interest, too. The interest rate investors receive is set at the time of the initial investment based on Percent’s evaluation of the credit and market demand via our Dutch auction system.

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