An Introduction to Financial Markets – Debt Market and Equity Market

Investing money in financial markets requires consideration of investment types, basic structure, motive, risks, and returns associated with the market. An individual investor must make sure to assess every detail of every market before making any investment. It is important to make informed decisions, which is why we have compiled everything you need to know about investing in Financial Markets, namely Debt and Equity Markets. 

In this article, we will talk about the two different financial markets a person can invest in. The risks and returns that a person can expect in these markets, including some examples which will help you understand better 

Debt market and equity market are broad terms where two categories of investments that are bought and sold. They sit at two far ends of a very large curve. While equity markets consist of a company’s owned capital, debts are a company’s borrowed capital. The characteristics, risk, returns, basic structure and motive, everything differs between the two of them. 

What is Equity Market?

Equity markets trade in shares or stocks of the company listed on the stock exchanges. A stock in a company indicates a unit in the ownership of the company. As shareholders, you become part owners of the company. Equity or stocks represents the ownership of a company. You become the owner of the company you invested in, proportionating to the number of stocks you own of a company or the total number of stocks of the company *100. 

The stock may earn profits in the form of dividends. Dividends are the profits earned by the company which are given to shareholders as their share of profits in the proportion of their ownership. It is not always possible that a shareholder is earning dividends on a regular basis. A company might be incurring losses that have to be borne by the shareholder as well. 

What are the risks involved in Equity Market?

Equity markets are riskier than debt markets. Listed shares are traded daily between the market hours. Their returns are not guaranteed. Over the past few decades, the equity markets have given the most returns in India. Experts at Corporate Finance Institute advise that if a person is investing money in the equity market on their own should analyse the risk and return by doing proper research.

Types of Equity Markets:

Primary Market 

The primary equity market, where companies issue new securities, is divided into a private placement market, and a primary public market. In the private placement market, companies raise private equity through unquoted shares that are sold to investors directly. In the primary public market, private companies can go public through IPOs (Initial Public Offerings), and listed companies can issue new equity through seasoned issues. You may have heard about the infamous IPO of Zomato that was launched this year. This is the very first time the company is available for the general public to get the shares of. 

Secondary Market 

The secondary market is the market in which existing securities are bought and sold. This is the market in which investors and traders can buy and sell shares of a company. It is where existing shares are bought and sold, consisting of stock exchanges and over-the-counter (OTC) markets, where a network of dealer’s trade stocks without an exchange acting as an intermediary. There are numerous stocks that are available for the public in the secondary market to buy and sell are, some of the most popular ones are  – Reliance (RIL), Tata Consultancy Services Ltd(TCS),  Asian Paints etc.

What is the Debt Market?

While equity is a form of owned capital, debt is a form of borrowed capital. The central, state governments or companies can raise money from the market by issuing government securities, government bonds or corporate bonds. In effect, the entity is borrowing money from you and will pay interest to you at regular intervals. 

The debt markets are the markets in which bonds and securities and bought and sold by brokers or large institutions, or by individual investors. This is the market that is known for regular interest but at a low rate. We can consider it as a much safer option if we go for a long run investment that gives a person stability. 

What are the Types of Debt Market Instruments?

In debt market trading of securities takes place (i.e. buying and selling). All issuers of these securities according to their financial requirements and available options select the best debt instrument. 

Bonds 

Bonds are basically of two types, government bonds and corporate bonds. Government bonds hold lesser risk and would have a slightly less interest returns. Whereas Corporate bonds hold a higher risk and give a decently good amount of interest. The Bonds have a fixed coupon rate and pay that interest to the bondholder periodically. And also repay the principal amount at the time of maturity. The interest rates of bonds are variable in the case of Floating Rate Bonds.  

Government Securities 

These are debt instruments mostly issued by the Central Bank of the country, in place of the Central or State Government. These securities can be for the long term or short term. They give a fixed coupon rate to the investors. The Indian Government Bonds usually range from 5%-7% which can be changed every quarter, 6 months or yearly as per the governments choice, but we have seen fewer changes made by the government in the interest rate in accordance to various factors like inflation, money flow in the market etc.

Debentures 

Debentures are similar in nature to Bonds; the only difference is the security level.  Debentures are riskier in nature. Bonds can be issued by the government as well as companies, but debentures can only be issued by companies. An example of a debenture can be a treasury bond or treasury bill which is also known as T –bill. 

Risk and Returns in Debt Market

Corporate bonds work in a similar way but there are chances of company defaults that may put the bonds at risk. Government bonds are generally considered risk free, hence the returns are also moderate. Although Irrespective of that there are few risks, which are difficult to ignore and important to ne aware of before making an investment.

What are the risks involved in Debt Market?

Interest Rate Risk 

This is the most typical type of risk that is present in all debt market securities. The interest rate fluctuates in an open market. There are times when there is a high-interest rate in the market but the investor has invested for a lower fixed interest rate. In such a situation, the investors lose on to higher interest rates and get only the fixed interest rate. 

Credit Risk 

One of the most prevalent risks of the debt market is the risk of the credit of the issuer. Due to any unforeseen circumstances, the issuer might not be in a position to pay credit or interest. In the first resort, the risk is that of the lender and includes lost principal and interest,  disruption to cash flows, and increased collection costs 

Liquidity Risk 

Settlement of the debt security at times, acts as a risk, as the other party might not fulfil all requirements. There exist counterparty issues at the time of settlement. positions in many other asset classes, especially in alternative assets, cannot be exited with ease. In fact, we might even define alternative assets as those with high liquidity risks.

Different between the two Financial Markets can be summarised as below 

Key Takeaway 

• Both the markets possess risks, no market is risk-free. 
• If a person is looking for much more stability, he/she can opt for the debt market due to its less vitality. 
• If an individual is investing in the equity market, they should research the company thoroughly and make predictions and analyses accordingly.
• One of the best things an investor in equity or debt can do is to educate themselves and speak to a trusted financial advisor. Enwisen Global has a team of experienced professionals who can help you assess your options and make the right decision for your investment. 
• If invested with full knowledge a person can make a lot of money 
• There are certain documents you can refer to, to educate yourself more about the topics of financial markets, Debt Market and Equity Market.