This article needs additional citations for verification. Please help improve this article by adding reliable references. Unsourced material may be challenged and removed. (January 2009) For other uses see Debt (disambiguation). Personal finance Credit and debt

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Debt is that which is owed; usually assets owed but the term can also cover moral obligations and other interactions not requiring money. In the case of assets debt is a means of using future purchasing power in the present before a summation has been earned. Some companies and corporations use debt as a part of their overall corporate finance strategy.

A debt is created when a creditor agrees to lend a sum of assets to a debtor. In modern society debt is usually granted with expected repayment; in most cases plus interest. Contents 1 Etymology 2 Payment 3 Types of debt 4 Debt syndication 5 Fund base 6 Non Fund Base 7 Accounting debt 7.1 Securitization 8 Debt inflation and the exchange rate 8.1 Inflation indexed debt 9 Debt ratings risk and cancellation 9.1 Risk free interest rate 9.2 Ratings and creditworthiness 9.3 Cancellation 10 Effects of debt 11 Arguments against debt 12 Levels and flows 13 See also 14 References Etymology

The word comes from the French dette and ultimately Latin debere (to owe) from de habere (to have). The letter b in the word debt was reintroduced in the 17th century possibly by Samuel Johnson in his Dictionary of 1755 several other words that had existed without a b had them reinserted at around that time. Payment

Before a debt can be made both the debtor and the creditor must agree on the manner in which the debt will be repaid known as the standard of deferred payment. This payment is usually denominated as a sum of money in units of currency but can sometimes be denominated in terms of goods or services. Payment can be made in increments over a period of time or all at once at the end of the loan agreement. Types of debt A company uses various kinds of debt to finance its operations. The various types of debt can generally be categorized into: 1) secured and unsecured debt 2) private and public debt 3) syndicated and bilateral debt and 4) other types of debt that display one or more of the characteristics noted above.1 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 is the simplest form of debt. It consists of an agreement to lend a principal sum for a fixed period of time 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. 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 (mortgage)) 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.2 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. Debt syndication Further information: Syndicated loan Fund base Cash Credit This is the primary method in which banks lend money against the security of commodities and debt. It runs like a current account except that the money that can be withdrawn from this account is not restricted to the amount deposited in the account. Instead the account holder is permitted to withdraw a certain sum called "limit" "credit facility" in excess of the amount deposited in the account. Cash Credits are in theory payable on demand. These are therefore counter part of demand deposits of the Bank. Working capital: Firms need cash to pay for all their day-to-day activities. They have to pay wages pay for raw materials pay bills and so on. The money available to them to do this is known as the firm's working capital. The main sources of working capital are the current assets as these are the short-term assets that the firm can use to generate cash. However the firm also has current liabilities and so these have to be taken account of when working out how much working capital a firm has at its disposal. Working capital is therefore Current Assets (stock + debtors + cash) minus Current liabilities. Working capital is the same as net current assets and is an important part of the top half of the firm's balance sheet. It is vital to a business to have sufficient working capital to meet all its requirements. Many businesses have undergone bankcruptcy not because they were unprofitable but because they suffered from a shortage of working capital. Bank Overdraft: The word overdraft means the act of overdrawing from a Bank account. In other words the account holder withdraws more money from a Bank Account than has been deposited in it. An overdraft occurs when withdrawals from a bank account exceed the available balance which gives the account a negative balance - a person can be said to be "overdrawn". If there is a prior agreement with the account provider for an overdraft protection plan and the amount overdrawn is within this authorised overdraft then interest is normally charged at the agreed rate. If the balance exceeds the agreed terms then fees may be charged and higher interest rate might apply Term loan: Term Loan are the counter parts of Fixed Deposits in the Bank. Banks lend money in this mode when the repayment is sought to be made in fixed pre-determined installments. This type of loan is normally given to the borrowers for acquiring long term assets i.e. assets which will benefit the borrower over a long period (exceeding at least one year). Purchases of plant and machinery constructing building for factory setting up new projects fall in this category. Financing for purchase of automobiles consumer durables real estate and creation of infra structure also falls in this category. Bill discounting: Bill discounting is a major activity with some of the smaller Banks. Under this particular type of lending Bank takes the bill drawn by borrower on his(borrower's) customer and pay him or her immediately deducting some amount as discount/commission. The Bank then presents the Bill to the borrower's customer on the due date of the Bill and collect the total amount. If the bill is delayed the borrower or his customer pay the Bank a pre-determined interest depending upon the terms of transaction. Project Financing: Project finance is the financing of long-term infrastructure and industrial projects based upon a complex financial structure where project debt and equity are used to finance the project rather than the balance sheets of project sponsors. Usually a project financing structure involves a number of equity investors known as sponsors as well as a syndicate of banks that provide loans to the operation. Non Fund Base Letter of Credit: 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. Corporate finance Working capital Cash conversion cycle Return on capital Economic value added Just in time Economic order quantity Discounts and allowances Factoring (finance) Capital budgeting Capital investment decisions The investment decision The financing decision Sections Managerial finance Financial accounting Management accounting Mergers and acquisitions Balance sheet analysis Business plan Corporate action Societal components Financial market Financial market participants Corporate finance Personal finance Public finance Banks and Banking Financial regulation Clawback This box: view talk Accounting debt In national accounting debts are added according to those who are indebted. Household debt is the debt held by households. "National" or Public debt is the debt held by the various governmental institutions (federal government states cities ...). Business debt is the debt held by businesses. Financial debt is the debt held by the financial sector (from one financial institution to another). Total debt is the sum of all those debts excluding financial debt to prevent double accounting. These various types of debt can be computed in debt/GDP ratios. Those ratios help to assess the speed of variations in the indebtness and the size of the debt due. For example the USA has a high consumer debt and a low public debt while in eastern European countries the opposite tends to be true. 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. Securitization Main article: Securitization Securitization occurs when a company groups together assets or receivables and sells them in units to the market through a trust. Any asset with a cashflow can be securitized. The cash flows from these receivables are used to pay the holders of these units. Companies often do this in order to remove these assets from their balance sheets and monetize an asset. Although these assets are "removed" from the balance sheet and are supposed to be the responsibility of the trust that does not end the company's involvement. Often the company maintains a special interest in the trust which is called an "interest only strip" or "first loss piece". Any payments from the trust must be made to regular investors in precedence to this interest. This protects investors from a degree of risk making the securitization more attractive. The aforementioned brings into question whether the assets are truly off-balance-sheet given the company's exposure to losses on this interest. Debt inflation and the exchange rate As noted below debt is normally denominated in a particular monetary currency and so changes in the valuation of that currency can change the effective size of the debt. This can happen due to inflation or deflation so it can happen even though the borrower and the lender are using the same currency. Thus it is important to agree on standards of deferred payment in advance so that a degree of fluctuation will also be agreed as acceptable. It is for instance commoncitation needed to agree to "US dollar denominated" debt. 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. Inflation indexed debt Borrowing and repayment arrangements linked to inflation-indexed units of account are possible and are used in some countries. For example the US government issues two types of inflation-indexed bonds Treasury Inflation-Protected Securities (TIPS) and I-bonds. These are one of the safest forms of investment available since the only major source of risk that of inflation is eliminated. A number of other governments issue similar bonds and some did so for many years before the US government. In countries with consistently high inflation ordinary borrowings at banks may also be inflation indexed. Debt ratings risk and cancellation Risk free interest rate Main article: risk-free interest rate Finance Financial markets Bond market Stock market (equity market) Foreign exchange market Derivatives market Commodity market Money market Spot market (cash market) Over the counter Real estate Private equity Financial market participants: Investor and speculator Institutional and retail Financial instruments Cash: Deposit Option (call or put) Loans Security Derivative Stock Time deposit or certificate of deposit Futures contract Exotic option Corporate finance Structured finance Capital budgeting Financial risk management Mergers and acquisitions Accountancy Financial statement Audit Credit rating agency Leveraged buyout Venture capital Personal finance Credit and debt Student financial aid Employment contract Retirement Financial planning Public finance Government spending: Transfer payment (Redistribution) Government operations Government final consumption expenditure Government revenue: Taxation Non-tax revenue Government budget Government debt Surplus and deficit deficit spending Warrant (of payment) Banks and banking Fractional-reserve banking Central Bank List of banks Deposits Loan Money supply Financial regulation Finance designations Accounting scandals Standards ISO 31000 International Financial Reporting Economic history Stock market bubble Recession Stock market crash History of private equity v d e Lendings to stable financial entities such as large companies or governments are often termed "risk free" or "low risk" and made at a so-called "risk-free interest rate". This is because the debt and interest are highly unlikely to be defaulted. A good example of such risk-free interest is a US Treasury security - it yields the minimum return available in economics but investors have the comfort of the (almost) certain expectation that the US Treasury will not default on its debt instruments. A risk-free rate is also commonly used in setting floating interest rates which are usually calculated as the risk-free interest rate plus a bonus to the creditor based on the creditworthiness of the debtor (in other words the risk of him or her defaulting and the creditor losing the debt). In reality no lending is truly risk free but borrowers at the "risk free" rate are considered the least likely to default. 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. Ratings and creditworthiness Specific bond debts owed by both governments and private corporations is rated by rating agencies such as Moody's Fitch Ratings Inc. A. M. Best and Standard & Poor's. 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 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. Munich Re for example currently is rated Aa3 (as of 2004update). S&P and other rating agencies have slightly different systems using capital letters and +/- qualifiers. 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. Cancellation Main article: Debt relief Short of bankruptcy it is rare that debts are wholly or partially relinquished. Traditions in some cultures demand that this be done on a regular (often annual) basis in order to prevent systemic inequities between groups in society or anyone becoming a specialist in holding debt and coercing repayment see debt relief. An example is the Biblical Jubilee year described in the Book of Leviticus. 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. Effects of debt Debt allows people and organizations to do things that they would otherwise not be able or allowed to do. Commonly people in industrialised nations use it to purchase houses cars and many other things too expensive to buy with cash on hand. Companies also use debt in many ways to leverage the investment made in their assets "leveraging" the return on their equity. This leverage the proportion of debt to equity is considered important in determining the riskiness of an investment; the more debt per equity the riskier. For both companies and individuals this increased risk can lead to poor results as the cost of servicing the debt can grow beyond the ability to pay due to either external events (income loss) or internal difficulties (poor management of resources). Excesses in debt accumulation have been blamed for exacerbating economic problems.3 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. Arguments against debt This section's citation style may be unclear. The references used may be made clearer with a different or consistent style of citation footnoting or external linking. Main article: Criticism of debt Some argue against debt as an instrument and institution on a personal family social corporate and governmental level. Islam forbids lending with interest even today while the Catholic Church allowed it from 1822 onwards and the Torah states that all debts should be erased every 7 years and every 50 years (in the Jubilee year as described in the Book of Leviticus). 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. 4 Levels and flows Main article: Debt levels and flows Global debt underwriting grew 4.3% year-over-year to $5.19 trillion during 2004. It is expected to rise in the coming years if the spending habits of millions of people worldwide continue the way they do. See also Derivative (finance) Debt bondage Debtors' prison Financial markets List of finance topics Odious debt Revolving account Saving Equity Time value of money Thomson Financial League Tables References Joseph Swanson and Peter Marshall Houlihan Lokey and Lyndon Norley Kirkland & Ellis International LLP (2008). A Practitioner's Guide to Corporate Restructuring page 5. City & Financial Publishing 1st edition ISBN 9781905121311 Formally a discount of d% results in effective interest of d / (1 d)%. 5 Ways to Get Out of Debt Faster. Kiplinger. 2007. http://www.webcastr.com/videos/informational/5-ways-to-get-out-of-debt-faster.html.  Dubois & Anderson (2010) Managing household debts: Social service provision in the EU. Working paper. Dublin: European Foundation for the Improvement of Living and Working Conditions. http://www.eurofound.europa.eu/areas/socialprotection/householdebts.htm v d eDebt Debt instruments Bond Debenture  Corporate bond  Government bond  Municipal bond Loan Usury  Consumer lending  Predatory lending  Loan shark  Payday loan Managing debt Debt management plan  Consolidation  Debt-snowball method  Bankruptcy Debt collection and evasion Debt compliance  Collection agency  Garnishment  Tax refund interception  Debt bondage  Debtors' prison  Phantom debt  Charge-off  Strategic default Debt markets Fixed income  Consumer debt  Corporate debt  Government debt  Money market  Deposit account  Debt buyer  Securitization Debt in economics Debt levels and flows  External debt  Internal debt  Consumer leverage ratio Interest  Interest rate  Default  Insolvency