Question

Critically contrast between the equity and debt markets. You comparison should make reference to the current state of the equity and debt markets..

Answer 1

a) Debt market and Equity market

Debt market and equity market are broad terms for two categories of investment that are bought and sold.

The debt market, or bond market, is the arena in which investment in loans are bought and sold. There is no single physical exchange for bonds. Transactions are mostly made between brokers or large institutions, or by individual investors.

The equity market, or the stock market, is the arena in which stocks are bought and sold. The term encompasses all of the marketplaces such as the New York Stock Exchange (NYSE), the Nasdaq, and the London Stock Exchange (LSE), and many others.

b) What is Debt market?

Investments in debt securities typically involve less risk than equity investments and offer a lower potential return on investment. Debt investments by nature fluctuate less in price than stocks. Even if a company is liquidated, bondholders are the first to be paid.

Bonds are the most common form of debt investment. These are issued by corporations or by the government to raise capital for their operations and generally carry a fixed interest rate. Most are unsecured but are issued with a rating by one of several agencies such as Moody's to indicate the likely integrity of the issuer.

i) Risky Real Estate and Mortgage-Backed Debt

Real estate and mortgage debt investments are other large categories of debt instruments. Here, the underlying asset securing the debt is real estate know as the collateral. Many real estate- and mortgage-backed debt securities are complex in nature and require the investor to be knowledgeable of their risks.

ii) The Changing Value of Fixed-Rate Bonds

It is reasonable to ask why a fixed-rate investment can change in value. If an individual investor buys a bond, it will pay a set amount of interest periodically until it matures, and then can be redeemed at face value. However, that bond might be resold in the debt market, called the secondary market.

The bond retains its face value at maturity. However, its real yield, or net profit, to a buyer change constantly. It loses yield by the amount that has already been paid in interest. The investment value increases or decreases with the constant fluctuations in the going interest prices offered by newly-issued bonds. If the interest rate of return on the bond is higher than the going rate, and the bond a reasonable time until maturity, the value may be at par or above the face value.

Thus, in the secondary market, the bond will sell at a discount to its face value or a premium to its face value.

c) What is Equity Market?

Equity, or stock, represents a share of ownership of a company. The owner of an equity stake may profit from dividends. Dividends are the percentage of company profits returned to shareholders. The equity holder may also profit from the sale of the stock if the market price should increase in the marketplace.

The owner of an equity stake can also lose money. In the case of bankruptcy, they may lose the entire stake.

The equity market is volatile by nature. Shares of equity can experience substantial price swings, sometimes having little to do with the stability and good name of the corporation that issued them.

Volatility can be caused by social, political, governmental, or economic events. A large financial industry exists to research, analyze, and predict the direction of individual stocks, stock sectors, and the equity market in general.

The equity market is viewed as inherently risky while having the potential to deliver a higher return than other investments. One of the best things an investor in either equity or debt can do is to educate themselves and speak to a trusted financial advisor.

Key Takeaways

• In the equity market, investors and traders buy and sell shares of stock.
• Stocks are stakes in a company, purchased to profit from company dividends or the resale of the stock.
• In the debt market, investors and traders buy and sell bonds.
• Debt instruments are essentially loans that yield payments of interest to their owners.
• Equities are inherently riskier than debt and have a greater potential for big gains or big losses.

d) Advantages of Debt Compared to Equity market

• Because the lender does not have a claim to equity in the business, debt does not dilute the owner's ownership interest in the company.
• A lender is entitled only to repayment of the agreed-upon principal of the loan plus interest, and has no direct claim on future profits of the business. If the company is successful, the owners reap a larger portion of the rewards than they would if they had sold stock in the company to investors in order to finance the growth.
• Except in the case of variable rate loans, principal and interest obligations are known amounts which can be forecasted and planned for.
• Interest on the debt can be deducted on the company's tax return, lowering the actual cost of the loan to the company.
• Raising debt capital is less complicated because the company is not required to comply with state and federal securities laws and regulations.
• The company is not required to send periodic mailings to large numbers of investors, hold periodic meetings of shareholders, and seek the vote of shareholders before taking certain actions.

e) Disadvantages of Debt Compared to Equity market

• Unlike equity, debt must at some point be repaid.
• Interest is a fixed cost which raises the company's break-even point. High interest costs during difficult financial periods can increase the risk of insolvency. Companies that are too highly leveraged (that have large amounts of debt as compared to equity) often find it difficult to grow because of the high cost of servicing the debt.
• Cash flow is required for both principal and interest payments and must be budgeted for. Most loans are not repayable in varying amounts over time based on the business cycles of the company.
• Debt instruments often contain restrictions on the company's activities, preventing management from pursuing alternative financing options and non-core business opportunities.
• The larger a company's debt-equity ratio, the more risky the company is considered by lenders and investors. Accordingly, a business is limited as to the amount of debt it can carry.
• The company is usually required to pledge assets of the company to the lender as collateral, and owners of the company are in some cases required to personally guarantee repayment of the loan.

f) The current state of the equity and debt markets

The year 2018 has been a yoyo year in debt markets. From a clamour for rate hikes to a whisper of rate cuts, the markets have seen a large move in both directions over the course of the year. The year was also an eventful one for debt market participants. From the flip flop on policy action to the spat between the Reserve Bank of India (RBI) and the government to the IL&FS default (pegged as India’s so-called Lehman moment) and the risk of contagion in the NBFC (non-banking financial company) space, the year has been an eventful one. Despite 2018 being a year of negatives, the bond market outperformed equity markets for the year. The year 2019 is likely to be a year of reversals, furthering the investment case for debt markets.

A stock market, equity market or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses; these may include securities listed on a public stock exchange, as well as stock that is only traded privately, such as shares of private companies which are sold to investors through equity crowdfunding platforms. Investment in the stock market is most often done via stockbrokerages and electronic trading platforms. Investment is usually made with an investment strategy in mind.

Stocks can be categorized by the country where the company is domiciled. For example, Nestlé and Novartis are domiciled in Switzerland and traded on the SIX Swiss Exchange, so they may be considered as part of the Swiss stock market, although the stocks may also be traded on exchanges in other countries, for example, as American depository receipts (ADRs) on U.S. stock markets.