Debt issuance is when companies or governments raise funds by borrowing money from bondholders. The company or government borrowing the money (issuing the debt) agrees to pay the lender (the bondholder) a set interest rate over a defined period. This payment, which is usually made monthly or quarterly, is sometimes called the coupon. At the end of the period, the borrower pays back the lender in full.
Kinds of Debt Issuances
The two most common kinds of debt issuances are governmental or corporate. Federal, state and local governments issue debt when they need money for capital projects such as building roads or schools, or for day-to-day operations. These debt issuances are called municipal or Treasury bonds. Companies issue debt to fund capital projects, acquisitions and more. These are called corporate bonds. Debt issuance is essentially a fancy term for borrowing money through the capital markets.
Setting the Interest Rate
A company or government is assigned a credit rating by a firm such as Moody's or Standard & Poor's. This rating determines the interest the entity will have to pay when issuing debt. Companies and governments with stable finances and sound balance sheets attain a higher credit rating than those with poor finances. A lower credit rating means the interest rate on the debt issuance will be higher, so it will cost more for the company or government to issue the debt.
Investment banks sell the company's or government's debt in the form of bonds on the bond market. The interest rate is set based on the credit rating and on demand from investors. Institutional customers such as pension funds or mutual funds are big buyers of debt issuances, though individuals can also buy the debt. After this process occurs, the borrower receives the cash from the debt issuance and the lenders receive the bonds.
Bonds Trade Hands
After the debt is issued, the borrower has a set interest rate that it has to pay for a certain length of time (often 10 to 30 years). But the bonds that it issues frequently trade hands on the open market, with prices rising and falling. The price the buyer pays affects the interest rate for the buyer, but the debt issuer continues to pay the same interest rate as was established when the bonds were first sold.
Debt Paid Back
Each debt issuance has a certain term, often 30 years. At the end of that period, the borrower is required to pay back the lender's principal in full. The lender also received the interest payments (coupons) throughout the term of the debt issuance. Sometimes interest rates will fall during the term of the debt issuance, and the borrower can buy back the bonds (call them) and issue new debt on cheaper terms.