A debt security is any type of debt instrument that can be purchased or sold, and that carries some type of maturity date and a rate of interest that is applied to the balance of the debt. Sometimes referred to as a fixed-rate security, a debt security is normally bought and sold over the counter. Securities of this type are often held and traded by larger institutions, as well as a number of non-profit organizations and even government agencies.
One of the best examples of a debt security is the bank certificate of deposit. Financial instruments such as bank CDs are considered debt instruments, in that the bank customer is lending his or her money to the institution for a specified period of time. In exchange for the loan, the bank applies a certain amount of interest to the balance of the deposit, with all the interest credited to the owner of the CD at or before the date of maturity.
Government and corporate bonds are also excellent examples of debt securities. With a bond issue, the lender invests a certain amount of money, and can expect to recoup both that original investment plus some type of return once the issue reaches full maturity. In the interim, the debtor has the use of the funds received from the bond issue, making it possible to fund projects that eventually become profitable and generate revenue that allows the debtor to repay the loan, along with the applicable interest.
Even something as simple as an IOU or a promissory note can be considered a debt security. As long as there is a specific date in which the loan is to be repaid in full, and there is some sort of interest that is paid along with the full amount of the original loan, it qualifies as this type of security. While these forms of debt instruments are used less frequently today than in times past, they do still represent a situation in which a lender is assuming some degree of risk, and is charging interest based on the perceived ability of the debtor to repay the loan.
This instrument is generally considered to carry less risk than most types of equity securities. This is because the face value of the loan is not subject to change, based on shifts in the economy. While there are some instances where the rate of interest applied is variable rather than fixed, the necessity of repaying the amount of the original investment remains the same.
