There are four basic types of credit market instruments, and the types of credit market instruments are distinguished by the timing of cash flow payments of each instrument. The different types of credit market instruments are simple loans, fixed-payment loans, coupon bonds, and discount bonds. Each of these is explained below:
- Simple Loan – the lender provides the borrower with a number of funds that must be repaid to the lender at the maturity date along with an additional payment for the interest. Many money market instruments are of this type: for example, commercial loans to businesses.
- Fixed-payment Loan – fixed payment loan is sometimes called a fully amortized loan. A mortgage is an example of an amortized loan, it allows the lender to receive the same amounts of money every period, like every month, which will consist of the principal and the interest for a set number of years.
- Coupon bond – a coupon bond pays the holder of the bond a fixed interest payment (coupon payment) every year until the maturity date when the face value or par value of the bond will be paid. There are three main distinctive characteristics of the coupon bond, namely the corporation or government issuing the bond, the coupon rate, and the maturity date of the bond. A coupon rate of 10% and R1 000 par value of the bond, MEANS that the holder will receive R100 per year as coupon payments before the date of maturity.
- Discount Bond – discount bond are bonds which are sold at a price below their face value. In comparison to the coupon bond, the discount bond does not make an interest payment, instead, the face value of the bond will just be paid on the date of maturity. 10% discount bond, with a face value of R1 000, means that the bond will be bought at R900 and sold at R1 000 on the date of maturity.
Simple loan and discount bonds make payments only at their maturity dates, whereas fixed- payments loans and coupon bonds make payments periodically until maturity.
