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Debt is an obligation that requires one party, the
debtor A debtor or debitor is a legal entity (legal person) that owes a debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series ...
, to pay
money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the left corner">174x174px Money is any item or verifiable record that is generally a ...

money
or other agreed-upon value to another party, the
creditor A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' party in 19th century Denmark A party is a gathering of people who have been invited by a host A host is ...

creditor
. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The debt may be owed by
sovereign state A sovereign state is a polity, political entity represented by one centralized government that has sovereignty over a geographic area. International law defines sovereign states as having a permanent population, defined territory, one government ...
or country,
local government Local government is a generic term for the lowest tiers of public administration Public administration is the implementation of public policy, government policy and also an academic discipline that studies this implementation and prepares civ ...
,
company A company, abbreviated as co., is a legal entity In law, a legal person is any person A person (plural people or persons) is a being that has certain capacities or attributes such as reason, morality, consciousness or self-consciousness ...

company
, or an individual. Commercial debt is generally subject to
contractual term A contractual term is "any provision forming part of a contract". Each term gives rise to a contract A contract is a legally binding document between at least two parties that defines and governs the rights and duties of the parties to an agr ...
s regarding the amount and timing of repayments of
principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academic officer of a university A university ( la, universitas, 'a whole') is an educational institution, institution of higher ...
and
interest In and , interest is payment from a or deposit-taking financial institution to a or depositor of an amount above repayment of the (that is, the amount borrowed), at a particular rate. It is distinct from a which the borrower may pay the len ...

interest
.
Loan In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money avai ...
s, bonds, notes, and
mortgages A mortgage loan or simply mortgage () is a loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The recipient (i.e., the borrower) incurs a ...
are all types of debt. In
financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such as businesses and corporat ...
, debt is a type of
financial transaction A financial transaction is an agreementAgreement may refer to: Agreements between people and organizations * Gentlemen's agreement A gentlemen's agreement, or gentleman's agreement, is an informal and legally non-binding wikt:agreement, agreem ...
, as distinct from
equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the differe ...
. The term can also be used metaphorically to cover
moral A moral (from Latin Latin (, or , ) is a classical language A classical language is a language A language is a structured system of communication Communication (from Latin ''communicare'', meaning "to share" or "to be in rel ...

moral
obligations and other interactions not based on a monetary value. For example, in Western cultures, a person who has been helped by a second person is sometimes said to owe a "debt of gratitude" to the second person.


Etymology

The English term "debt" was first used in the late 13th century. The term "debt" comes from "dette, from
Old French Old French (, , ; Modern French French ( or ) is a Romance language The Romance languages, less commonly Latin or Neo-Latin languages, are the modern languages that evolved from Vulgar Latin Vulgar Latin, also known as Popular o ...
dete, from Latin debitum "thing owed," neuter past participle of debere "to owe," originally, "keep something away from someone," from de- "away" (see de-) + habere "to have" (see habit (n.)). Restored spelling as usedafter c. 1400. The related term "debtor" was first used in English also in the early 13th century; the terms "dettur, dettour,
ame American English (AmE, AE, AmEng, USEng, en-US), sometimes called United States English or U.S. English, is the set of variety (linguistics), varieties of the English language native to the United States. Currently, American English is the mo ...

ame
from Old French detour, from Latin debitor "a debter," from past participle stem of debere;...The -b- was restored in later French, and in English c. 1560-c. 1660." In the
King James Bible The King James Version (KJV), also the King James Bible (KJB) and the Authorized Version, is an English translations of the Bible, English translation of the Christian Bible for the Church of England, which was commissioned in 1604 and publ ...
, only one spelling, "debtor", is used.


Principal

Principal is the amount of money originally invested or loaned, on which basis interest and returns are calculated.


Repayment

There are three main way's repayment may be structured: the entire principal balance may be due at the maturity of the loan; the entire principal balance may be
amortized In computer science, amortized analysis is a method for Analysis of algorithms, analyzing a given algorithm's Computational complexity theory, complexity, or how much of a resource, especially time or memory, it takes to Execution (computing), execu ...
over the term of the loan; or the loan may be partially amortized during its term, with the remaining principal due as a "
balloon payment A balloon payment mortgage is a mortgage A mortgage loan or simply mortgage () is a loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The ...
" at maturity. Amortization structures are common in
mortgage A mortgage loan or simply mortgage () is a loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The recipient (i.e., the borrower) incurs a ...
s and
credit card #REDIRECT Credit card A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay a merchant for goods and services based on the cardholder's promise to the card issuer to pay them for the amounts plus the ...

credit card
s.


Default provisions

Debtors of every type
default Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance) In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It ...
on their debt from time to time, with various consequences depending on the terms of the debt and the law governing default in the relevant jurisdiction. If the debt was secured by specific
collateral Collateral may refer to: Business and finance * Collateral (finance) In loan agreement, lending agreements, collateral is a Borrower, borrower's pledge (law), pledge of specific property to a lender, to Secured loan, secure repayment of a loan. ...
, such as a car or home, the creditor may seek to repossess the collateral. In more serious circumstances, individuals and companies may go into
bankruptcy Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditor A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' par ...

bankruptcy
.


Types of giving finance


Individuals

Common types of debt owed by individuals and households include
mortgage loan A mortgage loan or simply mortgage () is a loan used either by purchasers of real property to raise funds to buy real estate, or by existing property owners to raise funds for any purpose while putting a lien on the property being mortgaged. T ...
s, car loans,
credit card #REDIRECT Credit card A credit card is a payment card issued to users (cardholders) to enable the cardholder to pay a merchant for goods and services based on the cardholder's promise to the card issuer to pay them for the amounts plus the ...

credit card
debt, and
income tax An income tax is a imposed on individuals or entities (taxpayers) in respect of the income or profits earned by them (commonly called ). Income tax generally is computed as the product of a tax rate times the taxable income. Taxation rates may v ...
es. For individuals, debt is a means of using anticipated
income In microeconomics, income is the Consumption (economics), consumption and saving opportunity gained by an entity within a specified timeframe, which is generally expressed in monetary terms.Smith's financial dictionary. Smith, Howard Irving. 190 ...
and future
purchasing power Purchasing power is the amount of goods and services that can be purchased with a unit of currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" in the most specific sense is money Im ...
in the present before it has actually been earned. Commonly, people in industrialized nations use consumer debt to purchase houses, cars and other things too expensive to buy with cash on hand. People are more likely to spend more and get into debt when they use credit cards vs. cash for buying products and services.Prelec, D. & Loewenstein, G. (1998). The red and the black: Mental accounting of savings and debt. Marketing Science, 17(1), 4-28.Raghubir, P. & Srivastava, J. (2008)
Monopoly money: The effect of payment coupling and form on spending behavior
. Journal of Experimental Psychology: Applied, 14 (3), 213–25.
This is primarily because of the transparency effect and consumer's "pain of paying."Soman, D. (2003)
The effect of payment transparency on consumption: Quasi experiments from the field
Marketing Letters, 14, 173–183.
The transparency effect refers to the fact that the further you are from cash (as in a credit card or another form of payment), the less transparent it is and the less you remember how much you spent. The less transparent or further away from cash, the form of payment employed is, the less an individual feels the “pain of paying” and thus is likely to spend more. Furthermore, the differing physical appearance/form that credit cards have from cash may cause them to be viewed as “monopoly” money vs. real money, luring individuals to spend more money than they would if they only had cash available. Besides these more formal debts, private individuals also lend informally to other people, mostly relatives or friends. One reason for such informal debts is that many people, in particular those who are poor, have no access to affordable credit. Such debts can cause problems when they are not paid back according to expectations of the lending household. In 2011, 8 percent of people in the
European Union The European Union (EU) is a political and economic union of member states that are located primarily in Europe Europe is a which is also recognised as part of , located entirely in the and mostly in the . It comprises the wester ...

European Union
reported their households has been in arrears, that is, unable to pay as scheduled "payments related to informal loans from friends or relatives not living in your household".


Businesses

A
company A company, abbreviated as co., is a legal entity In law, a legal person is any person A person (plural people or persons) is a being that has certain capacities or attributes such as reason, morality, consciousness or self-consciousness ...

company
may use various kinds of debt to
finance Finance is a term for the management, creation, and study of money In a 1786 James Gillray caricature, the plentiful money bags handed to King George III are contrasted with the beggar whose legs and arms were amputated, in the left corn ...

finance
its
operations Operation or Operations may refer to: Science and technology * Surgical operation Surgery ''cheirourgikē'' (composed of χείρ, "hand", and ἔργον, "work"), via la, chirurgiae, meaning "hand work". is a medical or dental specialty that ...
as a part of its overall
corporate finance Corporate finance is the area of finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers a ...
strategy. A term loan is the simplest form of corporate debt. It consists of an agreement to lend a fixed amount of money, called the
principal sum Debt is an obligation that requires one party, the debtor A debtor or debitor is a legal entity (legal person) that owes a debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to ...
or principal, for a fixed period of time, with this amount to be repaid by a certain date. In commercial loans
interest In and , interest is payment from a or deposit-taking financial institution to a or depositor of an amount above repayment of the (that is, the amount borrowed), at a particular rate. It is distinct from a which the borrower may pay the len ...

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 loanIn banking and finance, a bullet loan is a loan where a payment of the entire principal Principal may refer to: Title or rank * Principal (academia) The principal is the chief executive and the chief academic officer of a university A univers ...
s", 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. A
revenue-based financingRevenue-based financing or royalty-based financing (RBF) is a type of financial capital provided to small or growing businesses in which investors inject capital into a business in return for a fixed percentage of ongoing gross revenues, with payme ...
loan comes with a fixed repayment target that is reached over a period of several years. This type of loan generally comes with a repayment amount of 1.5 to 2.5 times the principle loan. Repayment periods are flexible; businesses can pay back the agreed-upon amount sooner, if possible, or later. In addition, business owners do not sell
equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the differe ...
or relinquish control when using revenue-based financing.
Lenders A creditor or lender is a party 300px, '' Hip, Hip, Hurrah!'' (1888) by Peder Severin Krøyer, a painting portraying an artists' party in 19th century Denmark A party is a gathering of people who have been invited by a host A host is ...

Lenders
that provide revenue-based financing work more closely with businesses than bank lenders, but take a more hands-off approach than
private equity Private equity (PE) typically refers to investment funds, generally organized as limited partnerships, that buy and restructure companies that are not publicly traded. Private equity is a type of equity and one of the asset classes consisti ...
investors An investor is a person that allocates capital with the expectation of a future financial return (profit) or to gain an advantage (interest). Through this allocated capital most of the time the investor purchases some species of property. Type ...
. A
syndicated loan 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 lead arrangers. The syndicated loan market is the dominant way for la ...
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. A syndicated loan 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. Loan syndication is a
risk management Risk management is the identification, evaluation, and prioritization of risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty Uncertainty refers to Epistemology, epistemic situations involving ...

risk management
tool that allows the lead banks
underwriting Underwriting (UW) services are provided by some large financial institution Financial institutions, otherwise known as banking institutions, are corporation A corporation is an organization—usually a group of people or a company—a ...
the debt to reduce their risk and free up lending capacity. A company may also issue bonds, which are debt
securities A security is a tradable financial asset A financial asset is a non-physical asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication o ...
. Bonds have a fixed lifetime, usually a number of
year A year is the orbital period of a planetary body, for example, the Earth, moving in Earth's orbit, its orbit around the Sun. Due to the Earth's axial tilt, the course of a year sees the passing of the seasons, marked by change in weather, the ...
s; 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 In marketing, a coupon is a ticket or document that can be redeemed for a financial discount or rebate when purchasing a product. Customarily, coupons are issued by manufacturers of consumer packaged goods or by retailers, to be used in ...
) during the life of the bond. A
letter of credit . to bank in exchange for payment. Seller's bank then provides the bill to buyer's bank, who provides the bill to buyer. Image:Letter of credit 4.png, Image 4: Buyer provides the bill of lading to carrier and takes delivery of the goods. A lett ...
or 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 Land development is altering the landscape in any number of ways such as: * Changing landforms from a natural or semi-natural state for a purpose such as agriculture or House, housing * subdivision (land), Subdividing real estate into Lot (real est ...
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
giro A giro transfer, often shortened to giro (), is a payment transfer from one bank account A bank account is a financial account maintained by a bank or other financial institution in which the financial transactions between the bank and a cus ...
s and
traveler's cheque A traveller's cheque is a medium of exchange that can be used in place of hard currency. They can be denominated in one of a number of major world currencies and are preprinted, fixed-amount cheque A cheque, or check (American English; ...
. Typically, the documents a beneficiary has to present in order to receive payment include a
commercial invoice When used in foreign trade International trade is the exchange of capital, goods In economics Economics () is the social science that studies how people interact with value; in particular, the Production (economics), production, dis ...
,
bill of lading A bill of lading () (sometimes abbreviated as B/L or BOL) is a document issued by a carrier Carrier may refer to: Entertainment * Carrier (album), ''Carrier'' (album), a 2013 album by The Dodos * Carrier (game), ''Carrier'' (game), a South Pac ...
, 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. Companies also use debt in many ways for
capital expenditure Capital expenditure or capital expense (capex or CAPEX) is the money an organization or corporate entity spends to buy, maintain, or improve its fixed assets, such as buildings, vehicles, equipment, or land. It is considered a capital expenditure ...
s and other business
investment Investment is the dedication of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance Finance is the study of financial institution ...
s made in their
asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such a ...
s, "leveraging" the return on their
equity Equity may refer to: Finance, accounting and ownership *Equity (finance), ownership of assets that have liabilities attached to them ** Stock, equity based on original contributions of cash or other value to a business ** Home equity, the differe ...

equity
. This
leverage Leverage or leveraged may refer to: *Leverage (mechanics), mechanical advantage achieved by using a lever *Leverage (album), ''Leverage'' (album), a 2012 album by Lyriel *Leverage (dance), a type of dance connection *Leverage (finance), using giv ...
, the proportion of debt to equity, is considered important in determining the riskiness of an investment; the more debt per equity, the riskier.


Governments

Governments issue debt to pay for ongoing expenses as well as major capital projects.
Government debt In public finance, government debt, also known as public interest, public debt, national debt and sovereign debt, is the total amount of debt owed at a point in time by a government or sovereign state to lenders. Government debt can be owed to ...
may be issued by sovereign states as well as by local governments, sometimes known as municipalities. Debt issued by the government of the United States, called Treasuries, serves as a reference point for all other debt. There are deep, transparent, liquid, and open capital markets for Treasuries. Furthermore, Treasuries are issued in a wide variety of maturities, from one day to thirty years, which facilitates comparing the interest rates on other debt to a security of comparable maturity. In finance, the theoretical "
risk-free interest rate The risk-free interest rate is the rate of return In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and inv ...
" is often approximated by practitioners by using the current yield a Treasury of the same duration. The overall level of indebtedness by a government is typically shown as a ratio of debt-to-GDP. This ratio helps to assess the speed of changes in government indebtedness and the size of the debt due. The United Nations
Sustainable Development Goal 17 Sustainable Development Goal 17 (SDG 17 or Global Goal 17) is about "partnerships for the goals." One of the 17 Sustainable Development Goals The Sustainable Development Goals (SDGs) or Global Goals are a collection of 17 interlinked global g ...

Sustainable Development Goal 17
, an integral part of the
2030 Agenda The Sustainable Development Goals (SDGs) or Global Goals are a collection of 17 interlinked global goals designed to be a "blueprint to achieve a better and more Sustainability, sustainable future for all".United Nations (2017) Resolution adopt ...

2030 Agenda
has a target to address the external debt of highly indebted poor countries to reduce debt distress.


Municipalities

Municipal bonds (or muni bonds) are typical debt obligations, for which the conditions are defined unilaterally by the issuing municipality (local government), but it is a slower process to accumulate the necessary amount. Usually, debt or bond financing will not be used to finance current operating expenditures, the purposes of these amounts are local developments, capital investments, constructions, own contribution to other credits or grants.


Assessments of creditworthiness


Income metrics

The
debt service coverage ratioThe debt service coverage ratio (DSCR), also known as "debt coverage ratio" (DCR), is the ratio of operating income available to debt servicing for interest, principal and lease payments. It is a popular benchmark used in the measurement of an entit ...
is the ratio of income available to the amount of debt service due (including both interest and principal amortization, if any). The higher the debt service coverage ratio, the more income is available to pay debt service, and the easier and lower-cost it will be for a borrower to obtain financing. Different debt markets have somewhat different conventions in terminology and calculations for income-related metrics. For example, in mortgage lending in the United States, a
debt-to-income ratio In the consumer mortgage industry, debt-to-income ratio (often abbreviated DTI) is the percentage of a consumer's monthly gross income that goes toward paying debts. (Speaking precisely, DTIs often cover more than just debts; they can include princ ...
typically includes the cost of mortgage payments as well as insurance and property tax, divided by a consumer's monthly income. A "front-end ratio" of 28% or below, together with a "back-end ratio" (including required payments on non-housing debt as well) of 36% or below is also required to be eligible for a conforming loan.


Value metrics

The
loan-to-value ratio The loan-to-value (LTV) ratio is a financial term used by loan, lenders to express the ratio of a loan to the value of an asset purchased. The term is commonly used by banks and building society, building societies to represent the ratio of the fir ...
is the ratio of the total amount of the loan to the total value of the
collateral Collateral may refer to: Business and finance * Collateral (finance) In loan agreement, lending agreements, collateral is a Borrower, borrower's pledge (law), pledge of specific property to a lender, to Secured loan, secure repayment of a loan. ...
securing the loan. For example, in mortgage lending in the United States, the loan-to-value concept is most commonly expressed as a "
down payment Down payment (also called a deposit in British English), is an initial up-front partial payment for the purchase of expensive items/services such as a car or a house. It is usually paid in cash or equivalent at the time of finalizing the transaction ...
." A 20% down payment is equivalent to an 80% loan to value. With home purchases, value may be assessed using the agreed-upon purchase price, and/or an appraisal.


Collateral and recourse

A debt obligation is considered secured if creditors have recourse to specific
collateral Collateral may refer to: Business and finance * Collateral (finance) In loan agreement, lending agreements, collateral is a Borrower, borrower's pledge (law), pledge of specific property to a lender, to Secured loan, secure repayment of a loan. ...
. Collateral may include claims on tax receipts (in the case of a government), specific assets (in the case of a company) or a home (in the case of a consumer). Unsecured debt comprises financial obligations for which creditors do not have recourse to the
asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication of financial and non financial information about economic entity, economic entities such a ...
s of the borrower to satisfy their claims.


Role of rating agencies

Credit bureaus collect information about the borrowing and repayment history of consumers. Lenders, such as banks and credit card companies, use credit scores to evaluate the potential risk posed by lending money to consumers. In the United States, the primary credit bureaus are
Equifax Equifax Inc. is an American multinational consumer credit reporting agency A credit bureau is a data collection agency that gathers account information from various creditors and provides that information to a consumer reporting agency in the ...

Equifax
,
Experian Experian plc is an Anglo-Irish multinational consumer credit reporting company. Experian collects and aggregates information on over 1 billion people and businesses including 235 million individual U.S. consumer A consumer is a person or a g ...
, and
TransUnion TransUnion is an American Credit bureau, consumer credit reporting agency. TransUnion collects and aggregates information on over one billion individual consumers in over thirty countries including "200 million files profiling nearly every credit-a ...
. Debts owed by governments and private corporations may be rated by rating agencies, such as
Moody's Moody's Investors Service, often referred to as Moody's, is the bond credit rating In investment To invest is to allocate money Image:National-Debt-Gillray.jpeg, In a 1786 James Gillray caricature, the plentiful money bags handed to Kin ...
,
Standard & Poor's S&P Global Ratings (previously Standard & Poor's and informally known as S&P) is an American credit rating agency A credit rating agency (CRA, also called a ratings service) is a company that assigns credit ratings, which rate a debtor's abilit ...

Standard & Poor's
,
Fitch Ratings Fitch Ratings Inc. is an American credit rating agency and is one of the " Big Three credit rating agencies", the other two being Moody's Moody's Investors Service, often referred to as Moody's, is the bond credit rating business of Moody's Corp ...
, and A. M. Best. The government or company itself will also be given its own separate rating. These agencies assess the ability of the debtor to honor his obligations and accordingly give him or her a
credit ratingA credit rating is an evaluation of the credit risk of a prospective debtor (an individual, a business, company or a government), predicting their ability to pay back the debt, and an implicit forecast of the likelihood of the debtor Default (financ ...

credit rating
. Moody's uses the letters ''Aaa Aa A Baa Ba B Caa Ca C'', where ratings ''Aa-Caa'' are qualified by numbers 1-3. S&P and other rating agencies have slightly different systems using capital letters and +/- qualifiers. Thus a government or corporation with a high rating would have Aaa rating. A change in ratings can strongly affect a company, since its cost of
refinancing Refinancing is the replacement of an existing debt obligation with another debt obligation under different terms. The terms and conditions of refinancing may vary widely by country, province, or state, based on several economic factors such as in ...
depends on its
creditworthiness A credit risk is risk of default Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance) In finance Finance is the study of financial institutions, financial markets and how they ope ...
. Bonds below Baa/BBB (Moody's/S&P) are considered junk or high-risk bonds. Their high risk of default (approximately 1.6 percent 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 Default may refer to: Law * Default (law), the failure to do something required by law ** Default (finance) In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It ...
on their debt. These types of debt are frequently repackaged and sold below face value. Buying junk bonds is seen as a risky but potentially profitable investment.


Debt markets


Market interest rates


Loans versus bonds

Bonds are debt
securities A security is a tradable financial asset A financial asset is a non-physical asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication o ...
, tradeable on a
bond market The bond market (also debt market or credit market) is a financial market A financial market is a market Market may refer to: *Market (economics) *Market economy *Marketplace, a physical marketplace or public market Geography *Märket, an i ...
. A country's regulatory structure determines what qualifies as a security. For example, in North America, each security is uniquely identified by a
CUSIP A CUSIP is a nine-digit numeric (e.g. 037833100 for Apple Inc., Apple) or nine-character alphanumeric (e.g. 38259P508 for Google) code that identifies a North American financial security (finance), security for the purposes of facilitating Clear ...
for trading and settlement purposes. In contrast,
loan In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and management of money and investments. Savers and investors have money avai ...
s are not securities and do not have
CUSIP A CUSIP is a nine-digit numeric (e.g. 037833100 for Apple Inc., Apple) or nine-character alphanumeric (e.g. 38259P508 for Google) code that identifies a North American financial security (finance), security for the purposes of facilitating Clear ...
s (or the equivalent). Loans may be sold or acquired in certain circumstances, as when a bank
syndicates A syndicate is a self-organizing group of individuals, companies, corporations or entities formed to transact some specific business, to pursue or promote a shared interest. Etymology The word ''syndicate'' comes from the French language, French ...
a loan. Loans can be turned into securities through the
securitization Securitization is the financial practice of pooling various types of contractual debt such as residential mortgages, commercial mortgages, auto loans or credit card debt obligations (or other non-debt assets which generate receivables) and selling ...
process. In a securitization, a company sells a pool of assets to a securitization trust, and the securitization trust finances its purchase of the assets by selling
securities A security is a tradable financial asset A financial asset is a non-physical asset In financial accounting Financial accounting is the field of accounting Accounting or Accountancy is the measurement, processing, and communication o ...
to the market. For example, a trust may own a pool of home
mortgages A mortgage loan or simply mortgage () is a loan In finance, a loan is the lending of money by one or more individuals, organizations, or other entities to other individuals, organizations etc. The recipient (i.e., the borrower) incurs a ...
, and be financed by residential mortgage-backed securities. In this case, the asset-backed trust is a debt issuer of residential mortgage-backed securities.


Role of central banks

Central bank A central bank, reserve bank, or monetary authority is an institution that manages the and of a or formal monetary union, and oversees their . In contrast to a , a central bank possesses a on increasing the . Most central banks also have ...

Central bank
s, such as the U.S.
Federal Reserve System The Federal Reserve System (also known as the Federal Reserve or simply the Fed) is the central bank A central bank, reserve bank, or monetary authority is an institution that manages the and of a or formal monetary union, and ove ...
, play a key role in the debt markets. Debt is normally denominated in a particular
currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" in the most specific sense is money Money is any item or verifiable record that is generally accepted as payment for goods and services ...

currency
, and so changes in the valuation of that currency can change the effective size of the debt. This can happen due to
inflation In economics, inflation refers to a general progressive increase in prices of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a r ...

inflation
or
deflation In economics Economics () is a social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behav ...

deflation
, so it can happen even though the borrower and the lender are using the same
currency A currency, "in circulation", from la, currens, -entis, literally meaning "running" or "traversing" in the most specific sense is money Money is any item or verifiable record that is generally accepted as payment for goods and services ...

currency
.


Criticisms

Some argue against debt as an instrument and institution, on a personal, family, social, corporate and governmental level. Some
Islamic banking Islamic banking, Islamic finance ( ar, مصرفية إسلامية), or Sharia-compliant finance is banking A bank is a financial institution Financial institutions, otherwise known as banking institutions, are corporation A ...
forbids lending with interest even today. In hard times, the cost of servicing debt can grow beyond the debtor's ability to pay, due to either external events (income loss) or internal difficulties (poor management of resources). Debt with an associated interest rate will increase through time if it is not repaid faster than it grows through interest. This effect may be termed
usury Usury () is the practice of making unethical or immoral monetary loan In finance Finance is the study of financial institutions, financial markets and how they operate within the financial system. It is concerned with the creation and ...
, while the term "usury" in other contexts refers only to an excessive rate of interest, in excess of a reasonable profit for the
risk In simple terms, risk is the possibility of something bad happening. Risk involves uncertainty Uncertainty refers to Epistemology, epistemic situations involving imperfect or unknown information. It applies to predictions of future events, to ...

risk
accepted. In international legal thought,
odious debtIn international law International law, also known as public international law and law of nations, is the set of rules, norms, and standards generally accepted in relations between nations. It establishes normative guidelines and a common conceptua ...
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. International
Third World debt The debt of developing countries usually refers to the external debt External debt (or foreign debt) is the total debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, ...
has reached the scale that many
economist An economist is a professional and practitioner in the social science Social science is the branch A branch ( or , ) or tree branch (sometimes referred to in botany Botany, also called , plant biology or phytology, is the s ...

economist
s are convinced that
debt reliefDebt relief or debt cancellation is the partial or total forgiveness of debt, or the slowing or stopping of debt growth, owed by individuals, corporations, or nations. From antiquity through the 19th century, it refers to domestic debts, in particul ...
or
debt cancellationDebt relief or debt cancellation is the partial or total forgiveness of debt, or the slowing or stopping of debt growth, owed by individuals, corporations, or nations. From antiquity through the 19th century, it refers to domestic debts, in particul ...
is the only way to restore global equity in relations with the
developing nation Image:Imf-advanced-un-least-developed-2008.svg, 450px, Example of Older Classifications by the International Monetary Fund, IMF and the United Nations, UN from 2008 A developing country is a country with a less developed Industrial sector, i ...
s. Excessive debt accumulation has been blamed for exacerbating economic problems. For example, before the
Great Depression The Great Depression was a severe worldwide economic depression An economic depression is a sustained, long-term downturn in economic activity in one or more economies. It is a more severe economic downturn than a economic recession, recess ...
, the
debt-to-GDP ratio In economics Economics () is a social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behavio ...
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 A credit crunch (also known as a credit squeeze, credit tightening or credit crisis) is a sudden reduction in the general availability of loans (or credit) or a sudden tightening of the conditions required to obtain a loan from banks. A credit cru ...
followed.
Deflation In economics Economics () is a social science that studies the Production (economics), production, distribution (economics), distribution, and Consumption (economics), consumption of goods and services. Economics focuses on the behav ...

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 Consumption may refer to: *Resource consumption *Tuberculosis, an infectious disease, historically in biology: * Consumption (ecology), receipt of energy by consuming other organisms in social sciences: * Consumption (economics), the purchasing of ...
and investment. The reduction in demand reduced business activity and caused further unemployment. In a more direct sense, more
bankruptcies Bankruptcy is a legal process through which people or other entities who cannot repay debts to creditor A creditor or lender is a party (e.g., person, organization, company, or government) that has a claim on the services of a second party. ...

bankruptcies
also occurred due both to increased debt cost caused by deflation and the reduced demand. At the household level, debts can also have detrimental effects — particularly when households make spending decisions assuming income will increase, or remain stable, in years to come. When households take on credit 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__NOTOC__ Business failure refers to a company ceasing operations following its inability to make a profit (accounting), profit or to bring in enough revenue to cover its expenses. A profitable business can fail if it does not generate adequat ...
, illness, or home repairs. Over-indebtedness has severe social consequences, such as financial hardship, poor physical and mental health, family stress, stigma, difficulty obtaining employment, exclusion from basic financial services (
European Commission The European Commission (EC) is the executive branch The executive is the branch of government exercising authority in and holding Moral responsibility, responsibility for the governance of a State (polity), state. The executive executes a ...

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.


Levels and flows

Global debt
underwriting Underwriting (UW) services are provided by some large financial institution Financial institutions, otherwise known as banking institutions, are corporation A corporation is an organization—usually a group of people or a company—a ...
grew 4.3 percent year-over-year to during 2004.


History

According to historian
Paul JohnsonPaul Johnson may refer to: Musicians *Paul Johnson (producer) (1971–2021), American producer and DJ *Paul Johnson (singer), British soul singer of the 1980s *Paul Johnson (guitarist), American *Paul Francis Johnson, Australian bassist, frontman o ...
, the lending of "food money" was commonplace in
Middle East The Middle East ( ar, الشرق الأوسط, ISO 233 The international standard An international standard is a technical standard A technical standard is an established norm (social), norm or requirement for a repeatable technical task whi ...

Middle East
ern civilizations as early as 5000 BC. Religions like Judaism and Christianity for example, demand that debt be forgiven on a regular basis, in order to prevent systemic inequities between groups in society, or anyone becoming a specialist in holding debt and coercing repayment. An example is the Biblical Jubilee year, described in the
Book of Leviticus The Book of Leviticus () is the third book of the Torah Torah (; he, תּוֹרָה, "Instruction", "Teaching" or "Law") has a range of meanings. It can most specifically mean the first five books (Pentateuch or Five Books of Moses) of ...
. Similarly, in
Deuteronomy The Book of Deuteronomy (literally "second law" from Greek ''deuteros'' + ''nomos'') is the fifth book of the Jewish , where it is called ''Devarim'' ( he, דְּבָרִים), "the words f Moses F, or f, is the sixth Letter (alphabet), let ...
chapter 15 and verse 1 states that debts be forgiven after seven years. This is because biblically debt is seen as both the creditor and debtor responsibility. Traditional Christian teaching holds that a lifestyle of debt should not be normative; the Emmanuel Association, a
Methodist Methodism, also called the Methodist movement, is a group of historically related denominations Denomination may refer to: * Religious denomination, such as a: ** Christian denomination ** Jewish denomination ** Islamic denomination ** Hindu d ...

Methodist
denomination in the
conservative holiness movement The conservative holiness movement is a loosely defined group of theologically conservative Conservatism is an aesthetic, philosophy of culture, cultural, social philosophy, social, and Political philosophy, political philosophy, which se ...
, for example, teaches: "We are to refrain from entering into debt when we have no reasonable plan to pay. We are to be careful to meet all financial engagements promptly when due, if at all possible, remembering that we are to 'Provide things honest in the sight of all men' and to 'owe no man any thing, but to love one another' (Romans 12:17; 13:8)."


Further reading

* World Bank, 2019
''Global Waves of Debt: Causes and Consequences''
Edited by M. Ayhan Kose, Peter Nagle, Franziska Ohnsorge, and Naotaka Sugawara.


See also

* Debt theory of money *
Debt deflationDebt deflation is a theory that recession In economics, a recession is a business cycle contraction when there is a general decline in economic activity. Recessions generally occur when there is a widespread drop in spending (an adverse demand sho ...


References

{{Authority control Credit Personal financial problems Financial law