Debt market and equity market are two broad categories of investment available in the general investment milieu. They sit at two fag ends of a very large curve. While equity markets consist of a company’s owned capital, debts are a company’s borrowed capital. The characteristics, risk, returns, basic structure and motive, everything differs between the two of them. There is no one-size-fits-all investment product. Let’s delve deeper into the individual concepts and understand why even after being stark contrasts, they are equally important and inter-relatable at times.
In this article
How do equity markets work?
Meaning of equity: Equity markets trade in shares or stocks of the company listed on the stock exchanges. A stock in a company indicates a unit in the ownership of the company. As shareholders, you become part owners of the company. The largest shareholder, with 50% or more shares, becomes the owner of the company.
Risk and return: Equity markets are riskier than debt markets. Listed shares are traded daily between the market hours. Their returns are not guaranteed. They either come in the form of dividends or by selling your investment in the market at a higher mark-up, helping you to book profits. They are highly volatile and the numbers are governed by factors such as
- demand and supply
- company’s financial health
- sectoral performance
- quarterly results and more.
Returns there are correspondingly volatile as well. If held longer, equities can give you over 10-12% returns as well over a period of 7-10 years.
Research requirement: The level of research required in the debt and equity market is a bit different. Investing in stock markets requires an investor to be well-read and put in a lot of research. You need to do a careful study of financial statements, balance sheets, management and the general financial health of the company.
Who can invest in equity markets?
Here are quick pointers to understand the characteristics you need to be able to invest in stock markets:
- Higher risk profile
- More funding to cushion against volatility
- Perseverance to withstand market volatility and to stay invested
- Time to research and study the companies
- Patience for returns to rise and become stable as returns can go very high but are also volatile
How do debt markets work?
Meaning of debt: While equity is a form of owned capital, debt is a form of borrowed capital. The central or state governments raise money from the market by issuing government securities or bonds. In effect, the government is borrowing money from you and will pay interest to you at regular intervals. The principal amount is returned on maturity. In the same way, a company raises money from the market by selling debt market securities such as corporate bonds. The debt market is made up of bonds issued by government authorities and companies.
Risk and returns: In case of government bonds, the returns are guaranteed. There is a fixed rate of return promised by the government. Corporate bonds work a similar way but there are chances of company defaults that may put the bonds at risk. Government bonds are considered risk free. Hence the returns are also moderate. This is an important difference between the debt and equity market.
Research requirement: Research requirement is comparatively lesser in bonds. Especially when you don’t engage in frequent purchase and sale of bonds like in the case of stocks, there are lesser factors that govern the interest rate you receive on the money loaned out by you.
Also, the interest rate is guaranteed by the government. In case of corporate bonds, you still need to have basic level research of the company at hand but in general, bonds do not require you to be that upbeat on a comparative note.
Who can invest in debt markets?
Following are the factors that can help you to decide if you can invest in debt markets or not:
- Risk-averse investors
- Investors looking for guaranteed returns
- If you do not want to invest a lot of time researching
- If you want to park your money and leave it there and not worry much about it
How are the investors prioritised in the debt and equity market?
Investors in both markets hold different levels of priority when they are brought together and are definitely not on a level-playing field. One key difference between the debt market and the equity market is that in case a company faces a default situation and has to go for liquidation, then it is the bondholders that are given priority. In all cases of default across industries, creditors are the ones that are paid off first and in this case it is the bondholders. Shareholders or the owners of the company are given last priority.
Please note: This is with respect to corporate bonds only as it almost never happens that a government defaults on a bond is issued.
Difference between equity market and debt market
|Sr. No.||Equity Market||Debt Market|
|1)||Meaning||Equities are owned capital.||Debt is a form of borrowed capital.|
|2)||Who can issue||Companies registered with Sebi||Companies, governments|
|3)||Risk||High risk||Low-risk because government-backed however corporate bonds are risky|
|5)||Investor status||Shareholders, part owners in the company||Creditors to the company/government|
|6)||Nature of return||Dividends or profit booking while trading in the stock market||interest paid by the bond issuer|
|7)||Regulator||Sebi||RBI and Sebi in case of corporate bonds|
How can you invest in the two markets?
When it comes to how you can approach these two markets, there is not much difference between the debt market and the equity market. Both of them can be approached directly or through mutual funds however there are a few nuances that may be different.
Here are two ways you can access the equity market:
- Direct investment: You can invest in equities directly by buying the stocks listed on the stock exchanges individually. This method requires you to do more research on the individual companies that you want to invest in. You need to figure out which industry suits your investment profile more and then pick the top-performing companies with a strong growth trajectory.
- Mutual funds: You can invest in mutual funds which are pooled investment vehicles that collect money from all the investors and then, in turn, invest in equities. Here you will not be directly involved in investment decisions. There will be a fund manager who decided which stock to invest in. You will be paying a fee for the fund manager expertise along with any other charges that may be levied.
Here are two ways you can invest in debt markets:
- Direct investment: You can invest in bonds through private placement directly with the company in case of corporate bonds. In case of government bonds, RBI, the supervisor of government bonds organises auctions for the sale of these bonds. There are two ways in which you can participate in these auctions:
- Competitive bidding: Larger investors like mutual fund companies, banks, commercial firms and more participate via competitive bidding because the process is complicated
- Non-competitive bidding: This is an easier process for individual investors like high net worth individuals (HNI), retail investors and likewise. This can be done through online platforms. National Stock Exchange (NSE) has an app called NSE goBid where smaller investors can invest in government securities directly
- Mutual funds: This is an indirect way. The mutual fund industry, irrespective of debt or equity funds work in a similar way. There will be a fund manager that will decides which government securities to invest in. Debt or hybrid mutual funds are an indirect way to stay invested in debt markets.
The difference between the debt and equity market is not that complicated. It is very simple that equity markets are riskier but can give higher returns whereas the bond market is more subtle on both those factors. Within the bond market corporate bonds are riskier than government bonds. Based on your goals and risk profile you can allocate your capital towards both asset classes to achieve optimal diversification.