Debt and equity securities provide the economic fuel on which companies rely to run thriving businesses and to finance operating activities in both the short and long terms. In modern economies, all organizations -- including nonprofit institutions, government agencies and businesses -- seek funding by issuing debt and equity instruments in financial markets. These markets are also known as securities exchanges.
A debt instrument is a contract in which one party -- the borrower -- agrees to repay another party -- the lender -- at a specified future date, known as the maturity date. Examples include corporate bonds, accounts payable and interest. Short-term debt securities are instruments that a borrower must repay within a year. Long-term instruments have a maturity exceeding 12 months. In the corporate context, debt instruments may be secured or unsecured. Secured debt agreements require that a borrower provide a collateral -- or financial guarantee -- before a lender advances funds. Debt instrument holders, also known as bondholders, receive periodic interest payments during the loan term and the principal amount when the loan matures.
The debt-instrument market is key to the adequate functioning of global financial exchanges, as the market provides the liquidity pool needed in corporate activities, according to Kam C. Chan and P.V. Viswanath, finance lecturers at Pace University, and Annie Wong, an investment professor at Western Connecticut State University. Liquidity pool refers to the amount of cash available in a financial market at a given time. Without debt securities, companies may be unable to operate successfully in the short term because customers generally do not pay for goods on delivery.
Equity securities are portions of a company's ownership capital. In other words, buyers of equity instruments -- otherwise known as shareholders or stockholders -- own the company. Shareholders receive periodic dividend payments and make profits when share prices increase. Stockholders also participate in annual meetings and vote on important corporate affairs, including the appointment and compensation of senior management and directors.
Equity markets are important parts of the economy because they provide funding sources for companies. Organizations with sufficient funding levels also may engage in equity market transactions if financing costs -- that is, interest rates -- are lower than bank lending rates, according to the Department of Natural Resources of the Government of Newfoundland and Labrador.
Debt securities are distinct from equity instruments, but both assets often interrelate in the financial marketplace. In fact, investors who are interested in debt-equity products can purchase hybrid instruments, such as convertible bonds and preferred shares. These instruments allow an investor to benefit from positive market developments in equity or debt sectors, according to the Center for Excellence in Accounting and Security Analysis at Columbia Business School. For example, convertible bondholders can exchange their debt assets with equity products if stock market profits are expected to be higher than what bonds offer.