Also called the Securities Market, Capital market refers to a market where the funds from the investors are diverted to the companies and public institutions for development and other objectives. Likewise, if a business is looking for money to expand its operations, it can choose to issue shares in the stock market and investors who wish to invest in that business can buy the shares of the company. In this article we will discuss the importance of capital market and what are the most common instruments traded in the capital market.
The capital market can be bifurcated into two segments – primary and secondary. The primary capital market is where firms release stocks in the initial time, and a secondary market is the one which primarily deals in the trading of outdate or existing securities.
The Major Responsibilities of a Primary Market are:
- Beginning: Origination is inclusive of the inspection, evaluation, and process of fresh project suggestions in the primary market. It start before an issue is submitted in the market through commercial bankers.
- Underwriting: The primary task of underwrite is to guarantee the success of fresh issues that promise lowest subscription. When the issue stays unsold, it is subscribed by the underwriters.
- Distribution: The dealers and brokers are given the task of distribution who remains in direct contact with the investors. This ensure proper and timely distribution of the issues.
What are Capital Market Instruments?
Capital market instruments refer to the documents or certificates that act as an investment proof. There are several instruments traded in the capital market. Below are the most common instruments traded in the capital market:
Shares, also called stocks or equities, are typically released by the organizations. If you invest in a share or equity of by buying the same, you basically get a part of its ownership. Moreover, this bond of ownership through equity is everlasting in nature until it is given to investors in the tributary market or when the company gets settled.
It is important to keep in mind that equity investment allows investors to enjoy specific honours and rights in the company issuing shared, including voting privileges. An equity holder also gets an opportunity to receive returns in the form of dividends. In addition, given the performance or the business activities of the company, the worth of the equity goes up (when more investment comes in) or down (when investors part ways).
As the stock market are extremely unstable, the prices always move up and down. There are cases when the stock market faces a short-period cycle, despite the market not turning bullish or bearish. In this case Capital market gives more profit than other sector in share market.
Given this, though the returns from a share are comparatively higher among other capital market instruments, the risks are complex too. According to the best stock broker in India, “Most investors can invest their money in these instruments either in the primary (IPO) or secondary market”.
Companies, as well as pubic enterprises, choose to raise money for capital-based projects by releasing a debt instrument. As an outcome, this kind of instrument results in the formation of a borrower-creditor association. Thus, contrary to equities, debt instrument holders do not get any ownership in the issuing object.
In addition, the contract remains lawful for a specific period of time, for example, 3 years to 25 years. Interest, stated at the time of issue contribution, is given periodically on a yearly, semi-annual, or quarterly basis. An investor’s principal amount invested gets repaid when the contract period deceases.
During the liquidity of the company debt instrument investors get the top priority. Keeping that in mind, though the risk is less when compared to share investments, debt instruments are not totally risk-free. Furthermore, investment in debt instruments carry low levels of risks. This basically depends on the delivering unit. If a company is in poor financial condition and plans to raise capital by issuing bonds, one needs to be cautious, even if the interest rate is on an upper end.
These capital market instruments are extracted from other securities that are called fundamental assets. Although the type of related risk, purpose, and value of a derivative rests on its original assets, it is extremely volatile and comes with heavy risks as compared to equity. In addition, these instruments are highly erratic and mainly speculation-based. Some of the widely used derivative instruments in India are:
- Swap Contracts
- Future Contracts
- Commodities or Exchange Traded Funds
- Options Contracts
- Forwards Contracts
These shares are known to carry preferential privileges in an organization, in regard to dividend payment or pay-out during liquidation. In other terms, this refers that a business needs to first pay its preference shareholders. After this, the company can choose to pay its equity shareholders, particularly in terms of dividends.
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Thus, preference shares carry a few resemblances with debt instruments. But, preference shareholders don’t have carry voting privileges in comparison equity shareholders. However, they get a timely (generally assured) return on investment which compensates this inadequacy. If interest rates go up, their fixed dividend would go down.
The Major Types of Preference Shares are:
- Redeemable Preference Shares: The issuing business can redeem preference shares by choosing a buy-back in the future.
- Irredeemable Preference Shares: They only be redeemed if their issuing company liquidates itself.
- Convertible Preference Shares: These can be transformed into equity shares after a fixed time period.
It is necessary to keep in mind that as per the Companies Act, 2013, businesses in India cannot allocate unalterable preference shares. Instead, they must need to provide redeemable preference shares, which can be redeemed within an issuance period of 20 years.
The investors can invest in preference shares of a publicly-traded company like the way they do while buying common shares. These can be assimilated in either the main or ancillary market.