A Brief Introduction to Capital Market Instruments

What are the Functions of the Capital Market?

Capital market instruments are the best medium for organisational finance and provide various modes of investment to investors building capital.

The primary functions of the capital market are:

Facilitating the movement of capital to productive areas to augment the national income

What are the Types of Capital Market?

Primary Market

The primary market is a new issue dealing with new securities issues. Trading financial instruments are done here for the first time, also called IPO or Initial Public Offer.

The functions of the primary market are as follows:

Origination refers to the examination, assessment and process of new project proposals in the primary market. Origination begins before an issue is brought forward in the market with the help of commercial banks.

Secondary Market

The secondary market, also known as the stock market, is where trading occurs for existing securities. The securities are bought and sold here by the investors.

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The primary functions of the secondary market are:

What are the Instruments Traded in the Capital Market?

In the capital market, five types of instruments are traded. They are explained below.

Equities

Equities refer to the money invested in an organization by purchasing shares in the stock market.

Equity Shares: Equity shares are part ownership where the shareholders are fractional owners and initiate the maximum entrepreneurial liability related to a trading concern. Equity shareholders reserve the right to vote. However, holders of this instrument rank bottom on the scale of preference in the event of company liquidation because they are considered owners of the enterprise.

Preference Shares: Preference shares are issued by corporate bodies, and on the scale of preference, the investors rank second when the company goes under. These shares are often treated as debt instruments as they do not confer voting rights to the holders. They also have a dividend payment structured like a coupon or interest paid for bond issues.

Debt Securities

Debt securities are financial assets entitling the owners to a stream of interest payments. Borrowers must repay the principal borrowed and are classified into bonds and debentures.

Bonds: Bonds are fixed-income instruments primarily issued by the state and center governments, municipalities, and organisations for financing infrastructural development and other projects. It is referred to as a loaning capital market instrument, and the bond issuer is the borrower. Typically, bonds carry a fixed lock-in period, and on the maturity date, bond issuers must repay the principal amount to the bondholders.

Debentures: Debentures are unsecured investment options and not backed by any collateral. The lending is based on mutual trust. Investors act as potential creditors of the issuing company or institution.

Derivatives

Derivatives are capital market financial instruments. Their values are determined by underlying assets like stocks, currency, stock indexes and bonds. The most common types of derivative instruments are:

Forward: It is a contract between two parties in which the exchange occurs at the end of the contract at a specific price.

Future: It is a derivative transaction involving the exchange of derivatives on a determined future date at a predetermined price.

Frequently Asked Questions