Identification

• A debt security (also called a fixed-rate security) is essentially an IOU. It's a contract that can be bought or sold, made between a borrowing institution and the buyer of the security. The interest rate and the maturity or renewal date are stated. Most, but not all, debt securities are negotiable, meaning they're traded on financial markets.
  
  

Types

• Debt securities come in many forms. Negotiable bonds are sold by corporations and governments. When issued by state and local governments, they're referred to as municipal bonds. Short-term debt securities (with average maturities of 90 days or less) are generally traded separately and form the "money market." Some debt securities, such as certificates of deposit (CDs) and U.S. savings bonds, aren't negotiable and are marketed directly to individuals. Less familiar to the layperson are collateralized debt and mortgage obligations (CDOs and CMOs), in which an underlying debt like a mortgage provides the revenue to pay interest and retire the debt.
  
  

Yields

• When investors assess debt securities, they generally speak of yields rather than interest rates. The yield is simply the effective interest rate calculated by dividing the fixed payment a bond or other debt security pays by the price paid for that security. For example, a $5,000 face value bond might pay interest (called the coupon rate) of $400 per year (8.0 percent). If the bond is selling for $4,500 (90 percent of the face value), the yield is $400/$4,500, which equals 8.89 percent.
  
  

Non-Negotiable Debt Securities

• Some types of debt securities marketed to individuals aren't negotiable, and as such don't have a "price" set by market trading. This is the case with CDs and U.S. savings bonds. Both types of debt security have fixed values that must be redeemed upon maturity. Most feature fixed interest rates; a few types have variable interest rates. For example, Series I savings bond rates are periodically adjusted to compensate for inflation.
  
  

Considerations

• The price (and hence the yield) of debt securities is primarily governed by two market forces: prevailing interest rates and perceived credit risk. An increase in overall interest rates will tend to depress bond and other debt security prices because their existing yields become relatively less attractive to investors. Falling interest rates have the opposite effect: Prices go up as investor demand for the now more attractive debt security yields increases. Yields tend to be higher if the credit risk of a debt security is perceived to be high. For example, if bond rating services downgrade the rating for a corporation or municipality, the price of that institution's bonds is likely to fall, resulting in higher yields that compensate investors for the greater risk.