A debt instrument is any type of documented financial obligation that describes a debt that is assumed by the issuer of the document. Essentially, the instrument commits the issuer to reimburse the debt according to terms agreed upon between the buyer and the seller. Some examples of debt instruments include corporate and municipal bonds, Commercial Papers, Treasury Bills, and Certificates of Deposit.
One of the benefits of the debt instrument is that the document makes it possible to effectively transfer the ownership of debt. It is common for creditors to trade debt obligations as a means of generating revenue and keeping liquidity at a higher rate. The end result is that it is possible for lenders to make use of the funds collected from investors while still protecting those investments and be in a position to make interest payments as well as eventually repay the principle of the debt as well.
A Certificate of Deposit is a common debt instrument that is purchased by an investor. Considered a low risk investment, CDs allow the investor to make a modest return on the balance in the account over a period of time. While the funds are in the possession of the bank, the worth of the funds on deposit is used for trading debt and allowing the bank to remain liquid. As a result, the bank can make use of those funds to grow and still provide full coverage and a wide range of services to bank customers.
In like manner, bonds are also an example of a debt instrument that earns a modest but reliable return for the buyer. The bond issue may be structured to pay off the face value or amount of purchase plus interest at some agreed upon future date. Some bonds also issue periodic interest payments during the life of the bond. During this period, the buyer is earning a return and has full assurance of eventually recouping the initial investment as well. In the interim, the issuer of the bond is free to trade the debt in order to maximize the ability to make use of the debt instrument.
A commercial paper is a third example of an instrument of this type. Commercial papers are documents such as promissory notes that are intended to serve as documentation for short-term loans. The commercial paper helps to define the nature of the loan and may include information such as a date for the note to come due. Anyone holding a promissory note can trade the active note to another entity without impacting the commitment of the recipient of the note to repay the outstanding debt.
There are other forms of the debt instrument that are in common use today, such as mortgages and leases.
