What is Debt?

Learn about Debt with Aamir Khan
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Case breakdown: Movie Mann

The scene that you saw shows Karan Dev Singh (Played by Aamir Khan) being lectured by his friend. He is reminding Karan that he is broke and in debt. His bank balance is zero and even his clothes are borrowed. His friend is advising him to marry a millionaire’s daughter. This would help him to reduce his debt and deal with debtors.

In this blog, Learning Perspectives will explore the meaning of debt.

What is Debt?

In simple language, debt means borrowed money. Debt is used by both big and small corporations as a way of raising capital for their business. In a debt agreement, one party agrees to pay the money back at a later date along with interest. The most common form of debt is loans which include home loans, auto loans, personal loans, credit card debt, etc.

There are two main types of debt namely:

1. Secured Debt

2. Unsecured Debt

 Secured loans

These are those which require one to list something of value in order to guarantee the loan. Most standard types of mortgages and auto loans are considered secured credit because the loan holder can take possession of your house or car if you don’t pay as agreed. It is crucial that the lender vets the borrower for their creditworthiness and their ability to pay.

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Unsecured Loans

These loans don’t require any collateral. It’s based entirely on your good credit history. Most credit cards fall into this category.

Corporate Debt:

This debt is used by the corporate and is not available to individuals. Bonds and commercial papers are forms of debt instruments that are used for raising funds.  Commercial paper is a short-term debt with a maturity of 270 days. Bonds generally have a long-term maturity, it lasts over 15-20 years. There are 2 parties while making a bond contract: the Issuer (the Company that wants to raise funds) and the Investor (Who purchases bonds with a view of investment/saving).

Bondholders or investors are promised interest payments and payment of face value at the maturity date.

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Advantages and Disadvantages of Debt:

A company that has a higher percentage of debt in its capital mix can run out of money for interest payments when it goes into losses. It can have a negative net worth when it is suffering losses. This can lead to bankruptcy and the winding up of the company. While this can be a disadvantage for the business, there are many advantages too.

Securing debt financing can help the company to complete projects and generate revenue. Under equity financing, stockholders might interfere in running the business, when companies take term loans or through bonds or commercial paper, financial lenders do not interfere in the working of the company.

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