Debt vs Equity: The Fuel of Business
Companies need money to grow. They can either borrow it (Debt) or sell a piece of themselves (Equity). Understanding this balance is the key to understanding the entire stock market.
Key Takeaways
- ECM (Equity Capital Markets): Where companies sell shares (IPOs, Rights Issues). Investors become owners.
- DCM (Debt Capital Markets): Where companies borrow money by issuing Bonds. Investors become lenders.
- Cost: Debt is generally cheaper than Equity because interest is tax-deductible.
- Risk: Debt must be repaid (High Risk for Company). Equity doesn't need to be repaid (Low Risk for Company).
Part 1: The "Home Loan" Analogy
Let's say you want to buy a house worth ₹1 Crore. You have ₹20 Lakhs cash. You borrow ₹80 Lakhs from a bank.
- Your ₹20 Lakhs is EQUITY: You own the house. If the house price doubles, you keep all the profit. If it crashes, you lose your money first.
- The Bank's ₹80 Lakhs is DEBT: They don't care if the house price goes up or down. They just want their interest (EMI).
Companies work exactly the same way. They use a mix of Shareholders' Money (Equity) and Borrowed Money (Debt) to run the business.
Part 2: The Capital Structure Stack
If a company goes bankrupt, who gets paid first? This "Pecking Order" is crucial.
Who gets paid first? (In Bankruptcy)
Shareholders are "Residual Claimants". They get whatever is left after paying everyone else.
Debt Capital (DCM)
Instruments: Bonds, Debentures, Commercial Paper.
Why use it? Interest payments are tax-deductible. It's cheaper than giving away ownership.
Equity Capital (ECM)
Instruments: IPO, FPO (Follow-on Public Offer), Rights Issue.
Why use it? No obligation to pay back. Good for risky long-term projects.
Part 3: The Bond Market is HUGE
Did you know the Global Bond Market ($130 Trillion) is larger than the Stock Market? Governments and companies constantly issue bonds to fund operations.
Key Terms:
Coupon:
The interest rate paid by the bond.
Yield:
The effective return you get based on the bond's current market price.
Rating:
Agencies like CRISIL or Moody's rate bonds (AAA is safest, D is Default).
The FinKinetic Verdict
Debt is like
Fire
—useful for cooking (growth) but can burn down the house (bankruptcy) if uncontrolled.
Equity is like
Sharing your Meal
—safer, but you end up eating less (dilution).
Great companies use a balanced mix of both.
Frequently Asked Questions
What is a Rights Issue? ▼
It's when a company offers existing shareholders the 'Right' to buy extra shares at a discounted price. It's a way to raise equity without an IPO.
Why do stock prices fall when interest rates rise? ▼
When interest rates rise, borrowing becomes expensive for companies (hurting profits). Also, investors move money from risky stocks to safer bonds offering higher yields.