Debt Lender vs. Equity Investor
Original post by Geri Terzo of Demand Media
Debt lenders and equity investors both participate in the capital markets, but each group has a distinct set of features. A debt lender is an investor who extends loans to issuers, such as companies, federal governments and local municipalities, in exchange for income. An equity investor obtains partial ownership in an issuing company, and can sell the financial security for a profit or a loss.
Equity investors can apply a short-term or long-term strategy depending on the goal, which could be saving for retirement or earning a quick profit, for instance. A common strategy for equity investors is to purchase stocks that appear to be undervalued and subsequently profit from an expected rise in price. If the market price does not increase as expected, the investor faces a loss. An equity investor is not limited to the pre-set returns that bonds distribute, and can continue to earn profits as long as a stock is rising.
Bonds can be issued in time increments ranging from three months to three decades. Debt lenders are entitled to interest payments until an agreement expires. This rate represents a bond's yield. According to the "Los Angeles Times," in 2011 even after US credit was downgraded by ratings agency Standard & Poor's, bond investors seeking stable investments continued to buy government-issued debt securities, which drove bond prices higher and pushed yields lower. Institutional investors were not deterred by lower rates and preferred to buy long-term debt over short-term investments.
Equity investors typically take on more risk in comparison with debt lenders, according to the Russell Investments website. Stock investors do not earn steady income, unless the issuing entity decides to reward investors with dividends. An equity investor places a bet that a stock price will increase, but he has no assurance that this will happen. Bond investors bypass the potential profits in stocks for the reliability of fixed income payments inherent with bonds. The greatest risk for bond investors is the chance that an issuer will default.
Size and Influence
According to the Federal Reserve Bank of San Francisco, the debt capital markets were about double the size of the equity capital markets in 2005. In September of that year, corporations issued $218 billion in bonds and nearly $18 billion in equities. Nonetheless, each market category is needed, bonds for the role these debt securities play in interest rates, which influence the cost for other loans, and equities for giving corporations a means to expand and contribute to the economy.
- "Los Angeles Times"; Treasury Bond Yields Plunge as Panicked Buyers Ignore Downgrade; August 2008
- Russell Investments: Stocks & Bonds: How to Choose the Right Option
- Federal Reserve Bank of San Francisco; What Are the Differences Between Debt and Equity Markets?; October 2005
About the Author
Geri Terzo is a business writer with over 15 years experience reporting on Wall Street. Her coverage ranges from institutional investing, including hedge funds and investment banking, to family topics and her career experience includes work for Fox Business, CNBC and "IDD Magazine." Terzo is a graduate of Campbell University, where she earned a B.A. in mass communication.