Debt & Equity Instruments

One way for a company to grow and bring new products to the market is that it has to raise money. Two ways to raise money are first they can borrow it or, second they can sell shares of ownership in the company. Many companies also do both.

Companies are able to borrow money by taking out loans. The lenders then divide the loan into smaller pieces and sell the bonds or debt instruments in the secondary market. This allows each investor to be a creditor to the company. The company then takes the money raised and uses it as it sees fit.

Companies also raise money by selling ownership in the company. Companies divide the ownership into shares or equity instruments and then sell them to investors. The company to uses the proceeds from the sale of the shares as it sees fit.

As an investor in either a debt or equity instruments there are risks. With a debt instruments there is the major risk that the company will not be able to make the loan payments and will default on the loan and you will lose your principal that you loaned to the company. With equity instruments there is the risk that the company will not be successful and will go out of business, therefore making the shares you own worthless. In either case you are out the money that you have invested. If a company does go out of business, according to the current laws, creditors have first rights to any assets that are left in the company. So it is true that being a creditor carries a little less risk because you have first right to the assets over a shareholder, you can probably guess that you will still lose a major part of your investment if the company does go out of business.

There are some instruments that can cross the line between a debt and an equity instrument. The first is preferred stock. This type of instrument is an equity investment that works somewhat like a debt and somewhat like an equity instrument. This has a couple of meanings. First, preferred stock usually pays a higher and a fixed dividend. Second, if a company is unable to pay the dividend the dividend will accumulate until it is paid. For example,