Equity Markets vs Debt Markets
Individuals, corporations, and government bodies trade/invest in different kinds of assets as per their financial objectives. Equity/stock markets and debt/bond markets are the two main financial markets where most trading happens. Both can be used by companies and governments to raise capital through the issuance of various types of securities.
Investors, which can include individuals as well as large institutions, purchase securities with an intention to make profits. While equities allow investors to buy partial ownership of a company, debt securities represent loans given by investors to issuers in exchange for interest income.
Now, let us learn about the equity and debt markets in more detail.
What Is the Equity Market?
An equity market offers traders or investors buy and sell stocks. Investors can trade private (unlisted) or public (listed) stocks. Listed stocks can be purchased via IPOs and they are traded on stock exchanges like the Bombay Stock Exchange (BSE) or the National Stock Exchange (NSE). You can purchase or sell listed stock on these exchanges. The sale of unlisted stocks occurs over-the-counter (OTC).
In the equity market, companies sell their shares or equity in exchange for investors’ funds. On the other hand, investors purchase shares to earn profit from the growth of the company. Many companies also distribute their profits among shareholders as dividends.
How Do Equity Markets Work?
Equity markets are financial markets or marketplaces where individuals and institutions buy and sell shares. Primary exchange in equity markets occurs when a private company offers its shares to the general public and institutional investors through a process called the Initial Public Offering (IPO). In this exchange, the objective of the company is to gather funds or provide an exit to early investors in the company.
Once the shares are listed, a secondary exchange can take place on stock exchanges where investors can sell stocks to others. The issuing company has no direct gain from these sales.
In India, the Securities and Exchange Board of India (SEBI) oversees all equity-related operations. SEBI is the market regulator of our country. Investors need a demat account and a trading account to buy and sell shares in the country.
What Is the Debt Market?
Debt markets are financial marketplaces where debt securities are issued, bought, and sold. Examples of debt securities include corporate bonds, commercial papers, certificates of deposits, treasury bills, government securities, etc.
It is not an individual market; these exchanges take place through securities platforms, stock exchanges or also happen over-the-counter (OTC). Debt securities can be divided into two main types: government securities, which are issued by the Central and State Governments, and debt instruments issued by non-government institutions.
How do Debt Markets Work?
In India, the exchange of corporate bonds, government securities, and other debt securities takes place in the debt markets. Private companies and government bodies issue these fixed-income instruments in exchange for investors’ funds to expand their businesses or for working capital requirements.
Investors, in return, lend funds to issuers of debt securities to get fixed returns. The debt securities are ideal for risk-averse investors who want to invest their funds for the short term compared to equity investments. Debt securities typically have fixed maturity periods after which investors can collect their principal amount and interest. However, some securities pay interest or even principal at regular intervals which is pre determined at the time of issuance.
The SEBI and Reserve Bank of India (RBI) regulate the debt markets in India.
Features of Equity Investments
Equity markets offer assets that have the potential for high returns, which is one of the main t objectives of equity market investors. If you plan to invest in equity markets, it is important to learn its features and know if you are a suitable investor for such a market.
- High Returns
Equity markets are known for their high returns on investment.Historically, stocks of successful companies have significantly appreciated over time. Hence, investors seeking high returns are ideal investors for equity markets.
- High Risk
Equity markets depend on market trends; hence, they are highly volatile. Stocks are assets with high risk for investors. As it offers very high returns, they are preferred by investors willing to take the high risks involved with equity investments. Therefore, investors with a high risk appetite are suitable for equity markets.
- Short-Term Trading
Many traders participate in short-term trading on the equity markets. Traders can take part in intra-day, weekly or monthly trading, where an investor buys and sells a stock within a limited time span.
They study stock fundamentals and price behaviour, etc., to predict the future price movements of a particular stock. Depending on their predictions, they buy or sell stocks in short time spans to make profits. Equity markets are suitable for such traders.
- Long-Term Investment
Investors can reduce the market risk of equities by holding stocks over a long time to ride out losses. Hence, long-term investments generally offer high returns for an investor. Investors with long-term financial goals can invest in equity markets.
- Diversified Portfolio
Equity markets offer a wide variety of choices to investors who can plan and invest in multiple sectors to diversify portfolios and reduce risks. The equity market is an ideal choice for such investors.
Features of Debt Markets
Debt markets offer the advantage of fixed returns and low to moderate risks; hence it is a preferred option among risk-averse investors. The features of debt markets are given below:
- Low Risk
Debt instruments carry low risks compared to stocks, so investing excess capital in such instruments can be a strategic choice. Investors with a low-risk appetite are suitable for these financial markets.
- Fixed Returns
Debt market securities offer fixed returns as they mostly have fixed interest rates which do not fluctuate with changing market conditions. Investors who aim to earn static returns invest in such securities.
However, it is important to remember that debt securities do carry credit risks, where losses happen if the issuer defaults. This risk is higher for debt securities with lower credit ratings.
- Moderate Returns
Bonds and other securities in the debt market offer fixed but moderate returns compared to stocks depending on the quality of the instrument. Hence, investors whose objective is to park excess capital in safe instruments can invest in debt markets.
- Limited Scope
For higher returns, you cannot diversify your debt portfolio like equity, because higher returns would lead to higher risks, so the scope is limited for such investments compared to equity. However, you can diversify your portfolio by investing in both equities and debt securities.
What Are the Differences between Equity Markets and Debt Markets?
The parameters listed below show the main differences between equity and debt markets.
|Parameters||Equity Markets||Debt Markets|
|Risk Factor||Comparatively high risk, as such assets depend on various micro and macro economic factors..||Low-risk investments as returns do not depend on market trends.|
|Returns||Equity markets offer high returns on stocks as it also holds high risks.||Debt markets offer comparatively lower returns, usually at a fixed rate throughout the tenure.|
|Volatility||Equity markets are highly volatile.||Debt markets have low volatility.|
|Tenure||Equity market assets do not have a fixed tenure. The holding period generally depends on the investor’s objectives||Debt market assets mostly have a fixed tenure.|
|Type of Returns||In the case of equity markets, investors usually profit from capital appreciation. They can also earn dividends from certain stocks.||In debt markets, investors usually earn interest at fixed rates.|
|Status of Investor||Investors in equity markets are partial owners of companies they invest in.||Debt market investors are creditors to a company.|
Debt and equity markets have different advantages and disadvantages, which are suitable for different investors. You should choose which market is more convenient for you based on your appetite for returns and risks, investment objective, and capital.
SEBI and the RBI govern both markets, making them safe for investment or trading.
Frequently Asked Questions
What is the Reserve Bank of India (RBI)?
The RBI is the central bank of India that governs all banks and other financial institutions in this country and issues related to finance, economy and banking.
What are the types of equities?
Equities are mainly categorized into three main types. These three types of equities are common shares, preferred shares, and warrants.
What are the types of debt instruments?
Debt assets can be categorized into three main types. These three types of debt securities are corporate bonds, government securities, and money market instruments.
Why is it important to diversify your portfolio?
Investing your money in any financial market exposes you to various types of risks. Diversification provides a balance and safety against such risks; therefore, it is important to diversify your portfolio.