Know the different types of debt securities and dangers that come with them

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Conservative investors, by which we mean those who are risk-averse, prefer to invest in debt instruments rather than equity shares. The former is thought to be safer since creditors take precedence over shareholders if a firm runs into financial difficulties. As a result, debt instruments often provide lower returns than equity securities. Debt, on the other hand, comes in a variety of colors.

Debt issues are rated by credit rating companies such as CRISIL. Non-investment grade or junk bonds, on the other hand, are exceedingly risky. While AAA and AA rated securities are considered to be relatively safe, non-investment grade or trash bonds are extremely risky. Over a period of more than 80 years, no AAA-rated security in the United States missed a payment in the first year after the issue, according to historical statistics.

Treasury Securities

Treasury assets such as T-bills, T-notes, and T-bonds are safer since they are backed by the central or federal government’s full confidence and credit. G-Secs, like corporate debt, are subject to reinvestment risk in terms of coupons, as well as market risk or price risk if the security is sold before maturity. Another advantage of government securities over corporate debt is that they are usually more liquid.

It is not necessary for a security to be negotiable from a liquidity standpoint. National Savings Certificates (NSCs), for example, are not negotiable, although an investor can pledge securities and borrow against them. Many investors believe bank fixed deposits to be secure investments, especially in India, where the government owns the majority of the country’s major banks. However, with the government attempting to maintain a distance from the corporate sector, which includes the banking sector, it is unclear to what extent a country’s government will go to bail out struggling banks, even if they are public. The rise in the insurance ceiling for bank deposits in India under the Deposit Insurance Credit Guarantee Cooperation from Rs 1 lakh to Rs 5 lakh is a positive move.

Debt mutual funds

Debt mutual funds can be used as a substitute for bank deposits. Price risk is lower in liquid funds, extremely short-duration bond funds, and short duration bond funds. Furthermore, such funds contain a diverse portfolio of debt instruments, lowering the risk of default. An investor in a mutual fund can choose between growth, dividend, or dividend reinvestment, based on her needs. From a tax standpoint, such investments may be preferable because unitholders benefit from indexation.

For financial security, retirees rely significantly on debt. They should be well-versed on the options open to them, as well as the risks associated with them. Tax legislation and its implications for such investors must be kept up to date.

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