How Do I Deal with Long-Term Debt Instruments Issued by Firms With Excellent Credit Rating?

The most challenging part of the long-term debt instruments offered by financial institutions is understanding them. Conceptually, debt instruments are more complex than basic equity instruments (e.g. stocks), because debt instruments are further removed from the core product or service that is offered. For example, if you buy the stock of General Electric, you are essentially betting that you will profit from the stock if and when GE's revenue stream expands; however, when you buy a long-term debt obligations such as five-year corporate bonds, you are betting that the revenue stream of GE will expand in the future, surpass the rate of inflation and be appropriately paid off on time.

Instructions

1

Study economics. All debt instruments operate within the realm of economics, and you need to understand economics in the broadest capacity possible in order to best understand a particular debt instrument. The basic economics courses are microeconomics and macroeconomics; however, for a fuller comprehension of economics, study those courses in addition to microeconomic theory, macroeconomic theory, financial markets, econometrics and accounting. These latter courses will help you understand how debt functions on the accounting and how the viability of a debt instrument--as an investment--is impacted by the broader condition of the market at-large or the specific industry in which the asset underlying the debt instrument is located.

2

Review the asset underlying the debt instrument. Not doing so can lead to catastrophe. For example, owners of mortgage-backed securities in 2007 found the total value of these securities to be in absolute freefall. According to economist Nouriel Roubini, though the entire market owned these securities, very few economists and financial specialists had taken the time to investigate the exact assets underlying the securities and the exact process by which the market was accounting for these assets. In particular, the sub-prime housing industry imploded because homeowners could not pay the debts on the homes they were buying. In short: Investigate the value of the debt instrument at the very root to determine is true value--regardless of the credit-rating of the institution providing the debt.

3

Consult with the investor relations department of the firm and ask about the repayment schedule. You need to be familiar with the exact repayment terms of the debt instruments. For example, "preferred" sets of long-term debt obligations (e.g. preferred classes of corporate bonds) will be paid back before other asset classes of the same debt (e.g. non-preferred classes of corporate bonds). Knowing the repayment schedule of a long-term debt instrument will help you deduce whether purchasing it is consistent with your personal appetite for risk.