Updated: February 20, 2023
KEY TAKEAWAYS
- A debt issue happens when bonds or other debt instruments are offered by a creditor to help with borrowing capital.
- The seller of a debt issue will ensure an investor will receive regular interest payments. This is along with the final payment of the invested principal at the agreed-upon date.
- Usually, debt issues are in the form of fixed government or corporate obligations. These often include debentures and bonds.
What Is a Debt Issue?
A debt issue is a certain type of financial obligation. It allows a debt issuer to promise to pay the lender by raising funds at a point in the future. The amount of funds raised also aligns with the outlined terms of the original contract.
Some types of debt issues include things such as a government or corporate obligation, like a debenture or a bond. As well, other common types of debt issues include leases, mortgages, notes, certificates, and other agreements between the lender, the borrower, and the issuer.
Process of Debt Issuance
Before breaking down the process of debt issuance, it’s important to recognize that it can differ depending on if it’s for government debt issuance or corporate debt issuance.
With government debt issues, this process includes issuing debt in an auction format. Investors have the opportunity to purchase bonds through a dedicated website directly from the government. This website is called TreasuryDirect.
In this instance, having a broker isn’t a requirement and all transactions are handled electronically, including interest payments. Since debt issued by the government is backed by the credit of the U.S. government, it’s considered to be a safe investment.
Investors are essentially guaranteed that they will receive the face value of the bond including a certain interest rate. As well, the interest rates that are issued by the government are often lower compared to corporate bonds.
In the case of corporate debt issuance, this is a corporate action where the board of directors of a company needs to approve it. The board will draft a proposal to send to underwriters and investment bankers if debt issuance is a good option for raising capital. The board will also consider whether the company has sufficient cash flows to make the regular interest payments.
An underwriting process is usually most common for corporate debt issues. When this happens, one or more banks or securities firms will purchase the issue in its entirety. Then, they will form a syndicate that’s tasked with reselling and marketing the debt issue to interested investors.
The credit rating of the company, and the overall demand for the debt issuance, help determine the interest rate. It’s also worth mentioning that underwriters will often require a fee from the specific issuer for their services.
How Does a Debt Issue Work?
Usually, if a government agency or a company wants to take out a loan they’ll have one of two options. The first option, and often the most common, is obtaining financing from a bank. The second option is to issue debt to investors in capital markets.
When this happens, it’s considered a debt issue. Basically, this means that a debt instrument is issued by a specific entity that wants to raise capital, fund an existing project, fund a future project, or finance existing debt.
Oftentimes, issuing debt can be a preferred method to raise capital since securing a bank loan can come with restrictions. And in a lot of ways a debt issue is a promissory note. When this happens, the issuer of the debt becomes the borrower, and the buyer of the debt assets becomes the lender.
Investors will purchase a debt issue when it’s made available. In return, they’re promised regular interest payments as well as the total repayment of the initial principal amount. All of these details are agreed upon, including a predetermined date for this to happen in the future.
Summary
Issuing a debt asset is a way to use debt for capital projects and other types of financing needs. It’s a financial obligation that can be issued by a government or a corporation to help raise debt capital.
The cost of debt represents the debt commitments that are taken on by the issuer and the seller of the debt contracts. A debt issuance can help an economy function and it can often be utilized by private creditors.
Written byJami Gong, MPAcc, CPA
Jami Gong is a Chartered Professional Account and Financial System Consultant. She holds a Masters Degree in Professional Accounting from the University of New South Wales. Her areas of expertise include accounting system and enterprise resource planning implementations, as well as accounting business process improvement and workflow design. Jami has collaborated with clients large and small in the technology, financial, and post-secondary fields.
Written byJami Gong, MPAcc, CPA
Jami Gong is a Chartered Professional Account and Financial System Consultant. She holds a Masters Degree in Professional Accounting from the University of New South Wales. Her areas of expertise include accounting system and enterprise resource planning implementations, as well as accounting business process improvement and workflow design. Jami has collaborated with clients large and small in the technology, financial, and post-secondary fields.
FAQs About Debt Issue
Why Do Companies Issue Debt?
By issuing debts, companies can raise capital from investors. The company will become the borrower and any bondholders of the issue will become the creditors or lenders.
What Is Debt Issue Cost?
The debt issuance costs are the costs that come with issuing loans as bonds. These can include things such as the commissions and fees paid to law firms, regulators, auditors, and investment banks.
How Does a Bank Issue Debt?
The process of issuing debt usually happens through the underwriting process. This is when securities firms or banks purchase the debt issue and then resell it to interested investors.
How Are Debt Issuance Costs Treated?
The costs with debt issuance get deducted from the outstanding balance of the original obligation. As well, amortization of the costs is then charged as an interest expense. This can lead to a higher imputed interest rate which needs to be disclosed in financial statements.
