Debt market vs equity market: what is the difference?
By Indeed Editorial Team
Published 11 April 2022
The Indeed Editorial Team comprises a diverse and talented team of writers, researchers and subject matter experts equipped with Indeed's data and insights to deliver useful tips to help guide your career journey.
As you advance in your career, investing in the right market can help you supplement your income and grow your wealth. Two investments available are in the debt market and the equity market. Learning about their differences can guide your investment decisions, directing how and where to invest your money to yield significant returns. In this article, we discuss the debt market vs equity market, their definitions, differences, types, advantages and disadvantages.
Debt market vs equity market
To understand what debt market vs equity market is, know they're two categories of investment. The debt market involves lesser risk than the equity market but offers a lower return on investment. One of the most common forms of debt investments is bonds issued by the government or large corporations when raising capital for projects. The bonds usually come with a fixed interest rate. The general name for the equity market is the stock market. This market concentrates on stock investment. Buying a company's stock means buying a share of ownership and making profits as dividends.
As an investor in the stock market, you're a stock or shareholder. Dividends are what the company offers shareholders, which is a certain percentage of the company's profit. You can also profit by selling your stock if the market price increases. The equity market is risky as the market price can increase or decrease, leading to profit or loss. The volatility can result from political, governmental, social or economic events. Although the stock market is risky, it has a high potential to deliver a high return on investment if you do proper research and evaluation.
What is the debt market?
The debt market is where you can buy or sell debt market securities such as bonds, commercial papers, fixed deposits, national savings certificates, treasury bills and certificates of deposits. Those that issue these securities can be the state government, corporate organisations, local bodies, central government or other registered issuers. If you decide to invest in these securities, you can be sure of a fixed-rate regular interest payment.
Also, you can receive your principal payment at the time you set for it. For example, if you buy a treasury bill at 50,000 pounds, to end in five years, you can receive 5,000 pounds monthly as interest. By the end of five years, you get back your principal deposit, which is 50,000 pounds.
Issuers of debt market instruments
Before buying from the debt market, it's essential to investigate the issuer's creditworthiness. You can check the ratings of the issuers through credit rating agencies like Moody's or Fitch. These agencies research the credibility of the debt securities and give credit ratings. You can make investment decisions through these ratings. The following are some entities that issue:
Corporations: You can purchase debt market financial instruments from companies that require capital to finance their projects. They prefer going through the debt market as it's convenient compared to the equity market.
Bank and financial institutions: Financial institutions profit from lending businesses, so they raise funds for that purpose. They collect from the public, offering low-interest rates, then lend funds to borrowers charging them a high-interest rate.
State or central government: The central government may need funds for infrastructural projects or other programmes and might not have enough funds to execute them. So they raise money through the public, and when the projects make profits, they return the funds to the investors.
Municipal corporations: Like the central government, local bodies in towns or villages might need money for community structures or welfare programmes. They can also use debt instruments to raise funds.
Type of debt market instruments
The issuers of the securities select the best instruments that suit their financial requirements. Below are some details of the debt market instruments:
There are two major types of bonds, which are corporate and government bonds. Other types of bonds include institutions or municipal bonds. Corporate bonds offer a higher interest rate than the government but come with more risk. Although bonds generally have fixed interest rates, that's not true of Floating Rate Bonds. The changes in the economy dictate these types of bond interest. After buying a corporate bond, you can sell it back to the company after a particular time.
The central or state government issues these securities through the central bank. You can decide to invest in short-term government securities like treasury bills or long-term securities like bonds. It's a risk-free investment.
Debentures are debt instruments issued by companies. They follow the same pattern as bonds but have increased investment risks. There are different debentures, which are the registered or bearer debentures, the secured and unsecured debentures, the redeemable and non-redeemable debenture, the first and second debenture, the convertible and non-convertible debenture.
Advantages of the debt market
The following are some advantages of the debt market:
The debt market comes with lesser risk, especially government debt market securities.
It gives fixed returns to investors, making it easier for them to plan their spending, make future budgets or determine the worth of their portfolio.
This market helps the economy as companies can expand and grow through the funds raised, and governments can proceed with infrastructural projects that can help the life of citizens.
Disadvantages of debt market
The following are some disadvantages:
The inflation rate can affect the fixed returns, making them valueless to the investor
If there is a premature withdrawal, you can't get back your principal invested amount. You can only get the current market price.
Even when the company or government makes a considerable profit, you only get a fixed interest rate return.
What is the equity market?
This marketplace is where investors buy and sell public companies' shares. Companies take the first step in listing their stocks and then offer the public an opportunity to buy them. Investors can trade on the stock exchange platforms like the London stock exchange or over-the-counter (OTC) markets. In addition, the equity market provides a platform for investors to own company shares and expect a good return on their investment in the future.
Types of equity market
Two significant types of equity markets are the primary and secondary markets.
The company sells its shares directly to the public through the Initial Public Offering (IPO) or Follow-on-Public offering. For most companies, it's the first time they issue shares. When a company sells its shares, it has transited from a private company to a public company. This means that the company is now jointly owned by the shareholders. When buyers bid for stock, the company analyses them and allocates shares after considering the price and time of the bid.
The secondary market is for investors who were not opportune to participate in the company's IPO. It's a marketplace, either the stock exchange or over-the-counter exchange, where companies list their shares and investors buy and sell from each other. This market only caters to existing listed shares.
Equity market participants
The following participants play a role in the equity market:
Companies: Companies offer their shares to the public. They could be from any sector and size.
Retail investors and institutional investors: Retail investors are individuals like you who invest in shares but in a smaller amount than institutional investors who buy a significant number of shares.
Depository: These authorised bodies keep the electronic or physical share certificate for record purposes.
Clearinghouses: These participants set trades within three days of the transaction.
Stockbrokers: These participants serve as financial intermediaries between the investors and the stock exchange.
Stock exchange: The trading platform for shares
Banks: They're essential for transferring funds to aid trading.
Regulatory authority: This body protects the investor's interest, ensuring a safe trading zone and compliance with trading rules and regulations. The Financial Conduct Authority (FCA) is a regulatory body.
Related: How to become a stock broker
Advantages of equity market
These are the benefits of an equity market:
You can make a high profit from the equity market if you invest and sell at the right time.
There is a limited amount of risk to bear, and it only relates to the shares you bought.
You can get both your capital gain and dividend return by investing in this market.
You can vote on important decisions of the company.
You can quickly liquidate your shares.
Disadvantages of an equity market
When considering the equity market, understand there are several disadvantages that come with this type. These include a volatile market that can cause investment loss and minimal guarantee of returns. Consider the marketplaces when buying stocks to mitigate significant losses in the future.
Review of the differences
The difference between debt markets and equity markets are:
The debt market is less risky compared with the highly volatile equity market.
Although fixed, the debt market guarantees a return. With equity, there is no guarantee.
The debt market repays its debt holders first during liquidation while shareholders come last.
As an investor in the debt market, you're a debt holder and creditor of the company. In the equity market, you're a shareholder and the company's owner.
Debt holders have no voting rights, but shareholders can vote
As a debt holder, you get interest rates, and as a shareholder, you get dividends.
Please note that none of the companies mentioned in this article are affiliated with Indeed.
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