A debt is an obligation owed by one party (the debtor) to a second party, the creditor; usually this refers to assets granted by the creditor to the debtor, but the term can also be used metaphorically to cover moral obligations and other interactions not based on economic value.
A debt is created when a creditor agrees to lend a sum of assets to a debtor. Debt is usually granted with expected repayment; in modern society, in most cases, of the original sum plus interest.
In finance, debt is a means of using anticipated future purchasing power in the present before it has actually been earned. Some companies and corporations use debt as a part of their overall corporate finance strategy.
A debt obligation is considered secured, if creditors have recourse to the assets of the company on a proprietary basis or otherwise ahead of general claims against the company. Unsecured debt comprises financial obligations, where creditors do not have recourse to the assets of the borrower to satisfy their claims.
Private debt comprises bank-loan type obligations, whether senior or mezzanine. Public debt is a general definition covering all financial instruments that are freely tradeable on a public exchange or over the counter, with few if any restrictions.
A basic loan or "term loan" is the simplest form of debt. It consists of an agreement to lend a fixed amount of money, called the , for a fixed period of time, with this amount to be repaid by a certain date. In commercial loans interest, calculated as a percentage of the principal sum per year, will also have to be paid by that date, or may be paid periodically in the interval, such as annually or monthly. Such loans are also colloquially called bullet loans, particularly if there is only a single payment at the end – the "bullet" – without a "stream" of interest payments during the "life" of the loan. There are many conventions on how interest is calculated – see day count convention for some – while a standard convention is the annual percentage rate (APR), widely used and required by regulation in the United States and United Kingdom, though there are different forms of APR.
In some loans, the amount actually loaned to the debtor is less than the principal sum to be repaid; the additional principal has the same economic effect as a higher interest rate (see point), and is sometimes referred to as a banker's dozen, a play on "baker's dozen" – owe twelve (a dozen), receive a loan of eleven (a banker's dozen). Note that the effective interest rate is not equal to the discount: if one borrows $10 and must repay $11, then this is ($11–$10)/$10 = 10% interest; however, if one borrows $9 and must repay $10, then this is ($10–$9)/$9 = 11 1/9 % interest.
Rather than the entire principal amount of the loan being due at the end of the loan, the principal may be slowly repaid or "amortized" over the course of the loan – see amortizing loan. This is particularly common in mortgages and in the minimum payment on credit cards.
A syndicated loan is a loan that is granted to companies that wish to borrow more money than any single lender is prepared to risk in a single loan, usually many millions of dollars. In such a case, a syndicate of banks can each agree to put forward a portion of the principal sum. Loan syndication is a risk management tool that allows the lead banks underwriting the debt to reduce their risk and free up lending capacity.
A bond is a debt security issued by certain institutions such as companies and governments. A bond entitles the holder to repayment of the principal sum, plus interest. Bonds are issued to investors in a marketplace when an institution wishes to borrow money. Bonds have a fixed lifetime, usually a number of years; with long-term bonds, lasting over 30 years, being less common. At the end of the bond's life the money should be repaid in full. Interest may be added to the end payment, or can be paid in regular installments (known as coupons) during the life of the bond. Bonds may be traded in the bond markets, and are widely used as relatively safe investments in comparison to equity.
A syndicated loan is one that is provided by a group of lenders, and is structured, arranged, and administered by one or several commercial banks or investment banks known as arrangers.
The LC can also be the source of payment for a transaction, meaning that redeeming the letter of credit will pay an exporter. Letters of credit are used primarily in international trade transactions of significant value, for deals between a supplier in one country and a customer in another. They are also used in the land development process to ensure that approved public facilities (streets, sidewalks, stormwater ponds, etc.) will be built. The parties to a letter of credit are usually a beneficiary who is to receive the money, the issuing bank of whom the applicant is a client, and the advising bank of whom the beneficiary is a client. Almost all letters of credit are irrevocable, i.e., cannot be amended or canceled without prior agreement of the beneficiary, the issuing bank and the confirming bank, if any. In executing a transaction, letters of credit incorporate functions common to giros and Traveler's cheques. Typically, the documents a beneficiary has to present in order to receive payment include a commercial invoice, bill of lading, and a document proving the shipment was insured against loss or damage in transit. However, the list and form of documents is open to imagination and negotiation and might contain requirements to present documents issued by a neutral third party evidencing the quality of the goods shipped, or their place of origin.
There are differences in the accounting of debt for private and public agents. If a private agent promises to pay something later, it has a debt, and this debt is enforceable by public agents. If a public body passes a law stating that it'll pay something later (a kind of promise), it keeps the right to change the law later (and not to pay). This is why, for instance, the money governments promised to pay for retirements does not show up in the public debt assessment, whereas the money private companies promised to pay for retirements do.
The form of debt involved in banking accounts for a large proportion of the money in most industrialised nations (see money, broad money, and demand deposits for a discussion of this). There is therefore a relationship between inflation, deflation, the money supply, and debt. The store of value represented by the entire economy of the industrialized nation, and the state's ability to levy tax on it, acts to the foreign holder of debt as a guarantee of repayment, since industrial goods are in high demand in many places worldwide.
In countries with consistently high inflation, ordinary borrowings at banks may also be inflation indexed.
However, if the real value of a currency changes during the term of the debt, the purchasing power of the money repaid may vary considerably from that which was expected at the commencement of the loan. So from a practical investment point of view, there is still considerable risk attached to "risk free" or "low risk" lendings. The real value of the money may have changed due to inflation, or, in the case of a foreign investment, due to exchange rate fluctuations.
The Bank for International Settlements is an organisation of central banks that sets rules to define how much capital banks have to hold against the loans they give out.
A change in ratings can strongly affect a company, since its cost of refinancing depends on its creditworthiness. Bonds below Baa/BBB (Moody's/S&P;) are considered junk- or high risk bonds. Their high risk of default (approximately 1.6% for Ba) is compensated by higher interest payments. Bad Debt is a loan that can not (partially or fully) be repaid by the debtor. The debtor is said to default on his debt. These types of debt are frequently repackaged and sold below face value. Buying junk bonds is seen as a risky but potentially profitable form of investment.
Under English law, when the creditor is deceived into relinquishing the debt, this is a crime: see Theft Act 1978.
International Third World debt has reached the scale that many economists are convinced that debt cancellation is the only way to restore global equity in relations with the developing nations.
Excesses in debt accumulation have been blamed for exacerbating economic problems. For example, prior to the beginning of the Great Depression debt/GDP ratio was very high. Economic agents were heavily indebted. This excess of debt, equivalent to excessive expectations on future returns, accompanied asset bubbles on the stock markets. When expectations corrected, deflation and a credit crunch followed. Deflation effectively made debt more expensive and, as Fisher explained, this reinforced deflation again, because, in order to reduce their debt level, economic agents reduced their consumption and investment. The reduction in demand reduced business activity and caused further unemployment. In a more direct sense, more bankruptcies also occurred due both to increased debt cost caused by deflation and the reduced demand.
It is possible for some organizations to enter into alternative types of borrowing and repayment arrangements which will not result in bankruptcy. For example, companies can sometimes convert debt that they owe into equity in themselves. In this case, the creditor hopes to regain something equivalent to the debt and interest in the form of dividends and capital gains of the borrower. The "repayments" are therefore proportional to what the borrower earns and so can not in themselves cause bankruptcy. Once debt is converted in this way, it is no longer known as debt.
Debt will increase through time if it is not repaid faster than it grows through interest. This effect may be termed usury, while the term "usury" in other contexts refers only to an excessive rate of interest, in excess of a reasonable profit for the risk accepted.
In international legal thought, Odious debt is debt that is incurred by a regime for purposes that do not serve the interest of the state. Such debts are thus considered by this doctrine to be personal debts of the regime that incurred them and not debts of the state.
In an economy with high interest rates, debt will be more costly to a business than more flexible dividends on equity investment. It may be easier for a struggling business to be financed through equity investment as it may be possible to avoid paying a dividend if times are hard.
At the household level, debts can also have detrimental effects. In particular when households make spending decisions assuming income to remain the same -or increase- for the years to come. When households take-on credits based on this assumption, life events can easily change indebtedness into over-indebtedness. Such life events include unexpected unemployment, relationship break-up, leaving the parental home, business failure, illness or home repairs. Over-indebtedness has severe social consequences, such as, financial hardship, poor health (physical and mental), family stress, stigma, barriers to obtaining employment, exclusion from basic financial services (European Commission, 2009), work accidents and industrial disease, a strain on social relations (Carpentier and Van den Bosch, 2008), absenteeism at work and lack of organisational commitment (Kim et al, 2003), feeling of insecurity, and relational tensions.
Category:Credit * Category:Core issues in ethics Category:Personal financial problems
ar:قرض arc:ܝܙܦܬܐ zh-min-nan:Chè-bū ca:Deute ceb:Utang cs:Dluh de:Schulden eo:Ŝuldo fa:قرض fr:Dette ko:채무 hi:ऋण hr:Dug id:Utang it:Debito kn:ಋಣಭಾರ ht:Dèt la:Aes alienum lb:Schold (Recht) lt:Skola ln:Nyongo nl:Schulden ja:債務 no:Gjeld pl:Dług (ekonomia) pt:Débito ru:Долг sq:Borxhi scn:Detta simple:Debt sk:Dlh fi:Velka sv:Skuld (ekonomi) tl:Utang ta:கடன் th:หนี้สิน tr:Borç uk:Борг vi:Nợ bat-smg:Skuola zh:债务This text is licensed under the Creative Commons CC-BY-SA License. This text was originally published on Wikipedia and was developed by the Wikipedia community.
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