A debt investment is an investment in a firm through the purchase of a debt instrument as opposed to conventional equity investment in companies through buying common or preferred stock. Debt investments, also known as debt investment, include situations in which private investors finance debt products more commonly offered by banks or lenders.
One of the benefits of debt investment for corporations is that the company doesn't have to sell part of the company (as with a stock stale), diluting shareholder value, explains investment bank Carofin. Reviewing the basics of debt financing will help you better understand the practice of companies you are considering investing in.
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Consider also: Components of an Annual Report
Debt Investment Basics
Investing in debt has existed since Biblical times. What has changed in the 21st century is that more individual investors realize opportunities to profit from debt instruments previously offered by large banks or corporations. Rather than investing through acquisition of ownership in a firm or project, debt investors seek to profit from financing costs accepted by individuals and businesses willing to pay financing fees to obtain immediate access to cash. In addition, debt financing is cheaper than expansion through venture capital acquisition, according to Tech Day.com.
Consider also: The Key Differences Between Debt and Equity Financing
Selling Bonds to Raise Money
Bonds are one of the most common and obvious examples of a debt investment. Organizations issue bonds as a financing alternative to offer shareholders part ownership. Investors buy bonds with guaranteed repayment at a particular interest rate.
Corporations with high credit ratings usually pay less interest to bond holders because of their credibility. Growth companies or those considered more risky to bondholders pay higher interest yields on bond, presenting a higher risk, higher reward scenario for debt investors.
Consider also: What Affects Stockholders' Equity?
Other Debt Investments
Other common debt investments include tax liens, real estate contracts, car loan notes, and owner-financed mortgages. A pawn shop is also labeled a debt investment as is any investment set up with a promise of future cash flow in exchange for a purchase of a debt instrument in the current market.
During strong periods in real estate, private investment groups are often popular. These are privately funded mortgage investment groups that typically fund more risky loans for real estate developers and home buyers in exchange for liens against the property.
Unique Characteristics of Debt Investments
Investing in debt is quite different from buying CDs or investing in stocks. Debt investors are often much more active than stock investors and have to carefully study and learn about the debt instruments they invest in.
Debt investments are often considered unconventional by people that consider investing to mean buying equities or other conventional profit-generating investments. When entering the debt investment arena, it is a good idea to learn from veterans in the industry and to start conservatively.
Is Personal Debt Ever an Investment?
Let's say you're selling your house. If you spend $8,000 to install granite countertops and buy stainless steel appliances, you might be able to sell the house for $15,000 more. Even if you don't make that money back, you will probably be able to sell your house for your original hoped-for asking price and sell it faster.