Secrets the bankers do not

want you to know about debt

..Finally reveled

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Debt 1

Debt
Debt is that which is owed; usually referencing 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.

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.
Debt 2

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.

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:- WORKING CAPITAL = Current Assets || stock + debtors + cash - Current liabilities
Thus 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
gone under, not because they were unprofitable, but because they suffered from shortages of working capital.
Working Capital Cycle
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
Debt 3

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.

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
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
Debt 4

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
common 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

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.
Debt 5

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 2004). 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
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.
Debt 6

Arguments against 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.

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
• Nonfinancial debt
• Odious debt
• Revolving account
• Saving
• Equity
• Time value of money
• Thomson Financial League Tables

References
[1] 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
[2] Formally, a discount of d% results in effective interest of
[3] 5 Ways to Get Out of Debt Faster (http:/ / www. webcastr. com/ videos/ informational/ 5-ways-to-get-out-of-debt-faster. html). Kiplinger.
2007. .
Article Sources and Contributors 7

Article Sources and Contributors

Debt  Source: http://en.wikipedia.org/w/index.php?oldid=382438390  Contributors: ---Sol---, A. B., ALargeElk, Aaron Brenneman, Academic Challenger, Againme, Alanraywiki, Aliencafe,
Alpha 4615, Amatulic, Amnewsboy, Andman8, Andyj00, Arjan1071, Art Markham, Arthur Rubin, Athaenara, Aude, Awesome4262, Ayanoa, Bbatsell, Bcsman, BecomeDebtFree, BenPhil,
BobbyChristmas, Boccobrock, Borgx, Brian Pearson, Brian Sisco, Brookie, Bstroh, BuddyJesus, COMPFUNK2, Ccacsmss, Chris the speller, Chrylis, CliffC, Conny, Coolcaesar,
Creditwatchservices, DMCer, Daknightfall, Davehi1, David91, Dbarnes99, Ddon, Dee777, Deli nk, Derek Ross, Diegocerda, Diovi, Dluther31, DocendoDiscimus, Dspradau, Dylan Lake,
ENeville, ESkog, EagleOne, Edgar181, Edward, Epbr123, Everyking, Eviljanitor, Fael, Falcon8765, Fasmike, Feco, Felicity86, Fetchcomms, Flawiki, Fleelngc, Flyingmonkeyairlines, Fmarais,
Fragrant, Frank, Fredrik, Gail, Gamerider, Geneshapiro, Gilliam, Gimme danger, Gogo Dodo, Goldenlife, Goyaz, GraemeL, Gregalton, Guanaco, Gui le Roi, Gwernol, Hadal, Haemo, Happy big
boy, Heidistoll, Hellno2, Heron, HoulihanLokey, Inferno, Lord of Penguins, Inigmatus, IpWorld, IvanLanin, J heisenberg, JForget, JJHUser, JRR Trollkien, JamesBWatson, Janosabel, Jareha,
Javalizard, Jerryseinfeld, Jmichael ll, Joanjoc, Joeblogs webmaster, John Broughton, John Maynard Friedman, Johnwalton, Jpalmer90, Kbrian, Kharados, Kielsky, Koavf, Kohhei, Kubigula,
Kuru, Larapriyanka, Largedadjuggalo, Latka, Lawrencekhoo, Lazylaces, Ldonna, LeaveSleaves, Legis, Lesandjane, Levineps, Luke ormerod, MER-C, Madchester, Marauder40, Marianna1407,
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RadicalBender, Radon210, RainbowOfLight, Rajkiandris, Raul654, Rdsmith4, Responsible?, Retardo, Rhobite, Richhoncho, Rmorrison61, Road Wizard, Rodney Shakespeare, Rose68, Rpresser,
Rqtect, Rrburke, SDC, Sabine McNeill, Sarahgeorge, Scriberius, Sean7phil, Sheridan, ShinigamiKurosakiIchigo, SimonP, SimonTrew, Sionus, Smerkel, Socppt14, Spektrum808, Splintercellguy,
Srikeit, Stars4change, StephenMacmanus, SterlingTrust, Storm Rider, Svetovid, Tapedisc, TastyPoutine, Taxman, Tazmaniacs, Tcncv, Texture, Thaurisil, The Transhumanist, Thedrooling,
Thingg, Think outside the box, Timchat, Veinor, Versageek, Vulhr, WCityMike, Wavelength, Wik, Wimt, Wmahan, Wnissen, Xeno, Xylir, Yamamoto Ichiro, Zenohockey, Zhenqinli, Zzuuzz,
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