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There are many different debt markets that are all essentially based on basic loans between two parties, since the repayment of the debt creates a security. Bonds are the main debt instruments used by investors, who give loans to institutions in return for regular interest payments. Several different institutions which offer bonds, including governments, municipalities, and corporations, create distinct debt markets. These institutions vary in terms of the possible return they offer and the amount of risk involved for investors.
Novice investors often assume that the stock market is the only place where capital can be placed with the expectations that it will grow. Those investors are often overlooking the many opportunities for investments afforded by debt markets. These markets often focus on so-called fixed income securities, which promise regular return to investors. Bonds are the most popular fixed income securities, although some institutions also offer debentures, collateralized debt obligations, certificates of deposit, and many other instruments that promise regular return on investment capital.
When an investor buys a bond from the debt markets, he or she is essentially giving a loan to the issuer of that bond. In return, the investor generally receives the eventual return of the principal of the bond at the end of the bond term. On top of that, the investor is scheduled to receive interest payments at a percentage rate. This rate is specified at the beginning of the bond and is also known as the coupon rate.
Bonds in different debt markets usually offer coupon rates that are based on the amount of risk involved. The basic rule for debt instruments states that, as risk levels rise, so too do the attached coupon rates. In this way, the investor is compensated for the risk that the issuer might default on its payment obligations. Government bonds are generally the safest investments and, as such, have low coupon rates. Municipal bonds are also generally safe, since it rare for a town or city to suffer such financial calamities that they can't repay their loans.
On the other hand, corporate bonds represent the riskiest of the debt markets. There are certain corporations which offer bonds as a way to raise money, and some of these corporations are saddled with poor credit ratings. As a result, the bonds that they offer are often termed "junk bonds." These bonds can offer investors high interest payments, but only at the substantial risk that the corporation will default and even the investor's principal will be lost.
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