Instrument traded in the capital market

Instruments Traded In The Capital Market

The capital market is that section of the financial market that takes care of the effective channeling of medium to long-term funds from the surplus to the deficit unit. The process of transfer of funds is carried out through instruments, which are documents (or certificates), illustrating evidence of investments. The instruments traded or the means of exchange in the capital market are:

1. Debt Instruments

A debt instrument is made use of by either companies or governments to produce funds for capital-intensive projects. It can found either through the primary or secondary market. The relationship in this type of instrument ownership is that of a borrower – creditor and therefore, does not essentially imply ownership in the business of the borrower. The contract is for a particular duration and interest is paid at specific periods as stated in the trust deed* or contract agreement.

The principal sum invested, is thus repaid at the expiration of the contract period with interest either paid quarterly, semi-annually or annually. The interest mentioned in the trust deed may be either fixed or flexible. The tenure of this class varies from 3 to 25 years. Investment in this instrument is, often times, risk-free and thus yields lower returns when compared to other instruments traded in the capital market. Investors in this class are given top priority in the event of liquidation of a company.

When the debt instrument is issued by:

The Federal Government, it is known as a Sovereign Bond;

A state government it is known as a State Bond;

A local government, it is known as a Municipal Bond; and

A corporate body (Company), it is known as a Debenture, Industrial Loan or Corporate Bond

2. Equities or Common Stock

This instrument is issued by companies alone and can also be gotten either in the primary market or the secondary market. Investment in this type of business translates to ownership of the business as the contract stands in perpetuity except sold to another investor in the secondary market. The investor thus has specific rights and privileges like to vote and hold position in the company. While the investor in debts may be at liberty to receive interest which ought to be paid, the equity holder obtains dividends which may or may not be specified.

The risk factor in this instrument is high and therefore yields a higher return when successful. Holders of this instrument nevertheless rank bottom on the scale of preference in the event of liquidation of a company since they are taken as owners of the company.

3. Preference Shares

This instrument is issued by corporate bodies and the investors rank second (after bond holders) on the scale of preference when a company goes under. The instrument has the characteristics of equity because t when the authorized share capital and paid up capital are being calculated, they are added to equity capital to obtain the total. Preference shares can as well be treated as a debt instrument as they do not give voting rights to its holders and have a dividend payment that is planned like interest or coupon paid for bonds issues.

Preference shares may be:

Irredeemable, adaptable: in this instance, at the maturity of the instrument, the principal sum being returned to the investor is converted to equities although dividends (interest) had been paid before.

Irredeemable, non-adaptable: here, the holder can merely sell his holding in the secondary market as the contract will at all times be rolled over on maturity. The instrument will as well not be converted to equities.

Redeemable: In this type, the principal sum is paid back at the end of a particular period. In this instance it is treated strictly as a debt instrument.

Note: Interest may be cumulative, flexible or fixed depending on the agreement in the contract Trust Deed.

4. Derivatives

These are instruments that derive from other securities, which are known as underlying assets due to the fact that the derivative is derived from them. The price, riskiness and function of the derivative is based on the underlying assets since anything that affects the underlying asset ought to affect the derivative. The derivative may be an asset, index or even situation. Derivatives are mainly common in developed economies.

A few examples of derivatives are:

Mortgage-Backed Securities (MBS)

Asset-Backed Securities (ABS)

Futures

Options

Swaps

Rights

Exchange Traded Funds or commodities

Of all the above mentioned derivatives, the common one in Nigeria is Rights in which the holder of an existing security has the opportunity to obtain extra quantity to his holding in a specified ratio.

A Trust Deed is a document that states the terms of a contract. It is held in trust by the Trustee.

Capital market instruments are responsible for creating funds for companies, corporations and occasionally for national governments. These are made use of by the investors to make a profit out of their respective markets.

There are a number of capital market instruments made use of for market trade, including -

Stocks

Bonds

Debentures

Treasury-bills

Foreign Exchange

Fixed deposits, and others

Capital market is as well referred to as Securities Market due to the fact that long term funds are raised through trade on debt and equity securities. These activities may be carried out by both companies and governments. This market is divided into:

primary capital market and

secondary capital market.

The primary market is for the purpose of new issues and the secondary market is meant for the trade of existing issues. Stocks and bonds are the two essential capital market instruments used in both the primary and secondary markets.

There are three different markets in which stocks are used as the capital market instruments. They are: the physical, virtual, and auction markets.

Bonds, nevertheless, are traded in a different bond market. This market is as well referred to as a debt, credit, or fixed income market.

Trade in debt securities is carried out in this market. These are: the T-bills and Debentures. These instruments are more secure than the others, but they as well make available less return than the other capital market instruments.

While all capital market instruments are planned to bring a return on investment, the risk factors vary for each and the choice of the instrument depends on the choice of the investor.

The risk tolerance factor and the expected returns from the investment play a major role in the choice of an investor of a capital market instrument. The instruments ought to be chosen only after conducting proper research in order to increase one.

Capital and Money Markets

A financial market is a market that brings buyers and sellers together to trade in financial assets like stocks, bonds, commodities, derivatives and currencies. The aim of a financial market is to set prices for global trade, raise capital and transfer liquidity and risk. Even though there are a lot of constituents to a financial market, two of the key frequently used are money markets and capital markets.

Money markets are made use of for a short-term basis, normally for assets up to one year. On the other hand, capital markets are being made use of for long-term assets, which are any asset with maturity above one year. Capital markets are composed of the equity (stock) market and debt (bond) market. The money and capital markets are made up of a large portion of the financial market and are frequently used together to manage liquidity and risks for companies, governments and individuals.

Capital Markets

Capital markets are maybe the most broadly followed markets. Both the stock and bond markets are closely followed and their daily movements are analyzed as proxies for the general economic situation of the world markets. Owing to this, the institutions that operates in capital markets - stock exchanges, commercial banks and all forms of corporations, including nonbank institutions like insurance companies and mortgage banks - are cautiously examined and regulated.

The institutions that operate in the capital markets access them to raise capital for long-term purposes, like that of a merger or acquisition, to broaden their line of business or enter into a new business, or for other capital projects. Entities that are raising money for these long-term purposes gather at one or more capital markets. In the bond market, companies may issue debt in the form of corporate bonds, while both local and federal governments may issue debt in the form of government bonds.

Similarly, companies may decide to raise fund by issuing equity on the stock market. Government entities are basically not publicly held and, thus, do not normally issue equity. Companies and government entities that issue equity or debt are taken as the sellers in these markets.

The buyers, or the investors, buy the stocks or bonds of the sellers and trade them. If the seller, or issuer, is putting the securities on the market for the first time, then the market is referred to as the primary market. On the other hand, if the securities have already been issued and are currently being traded amongst buyers, this is done on the secondary market. Sellers make money off the sale in the primary market, not in the secondary market, even though they do have a stake in the outcome (pricing) of their securities in the secondary market.

The buyers of securities in the capital market tend to make use of funds that are targeted for longer-term investment. Capital markets are risky markets and are not normally made use of to invest short-term funds. A lot of investors access the capital markets to save for retirement or education, in so far as the investors have long time horizons, which normally entails that they are young and are risk takers.

Money Market

The money market is frequently accessed alongside the capital markets. Whereas investors are willing to take on more risk and have patience to invest in capital markets, money markets are a good place to "park" funds that are required in a shorter time period - normally one year or less. The financial instruments used in capital markets are stocks and bonds, but the instruments used in the money markets are deposits, collateral loans, acceptances and bills of exchange. Institutions that operate in money markets are central banks, commercial banks and acceptance houses, etc

Money markets make available a lot of different functions for either individual, corporate or government entities. Liquidity is frequently the main reason people access money markets. When short-term debt is issued, it is frequently for the aim of covering operating expenses or working capital for a company or government and not for capital improvements or large scale investments.

Companies may want to invest funds overnight and want the money market to achieve this, or they may be required to cover payroll and look to the money market to assist. The money market plays a major role in making sure that companies and governments maintain suitable level of liquidity on a day to day basis, without falling short and requiring a more expensive loan or without holding excess funds and missing the opportunity of obtaining interest on funds.

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