What are Capital Markets Instruments?

Capital market is a type of financial market where individuals and institutions trade in financial securities. The ultimate goal of the institutions that enter into the capital market is to raise money for long term purposes,primarily being expansion of business and increase of revenues.

Classification of Instruments

Pure Instruments

Equity Shares

• Known as ordinary shares.
• Larger share in profits through high dividends are given to equity shareholders.
• Holders enjoy substantial rights in corporate democracy.
• Unlimited potential for dividend payment as well as appreciation of value of shares with a fair amount of risks.

Debentures

• Type of debt instrument.
• Periodic interest payments are made to the debenture holders.
• Term is usually greater than 10 years.
• Used by large corporations to borrow money at a fixed rate.

Bonds

• Formal contract to repay borrowed money with an interest at fixed intervals.
• Key ingredient in an investment portfolio since it helps to balance out risk over time.
• Issued by companies who need funds for expansion.
• Less risky compared to stocks with a drawback of a lower return too.

Preference Shares

• Preference shareholders enjoy priority over dividends during the lifetime of the company and repayment of capital in the event of winding up of the company.
• No voting rights except in matters pertaining to their rights as preference shareholders.
• Percentage of dividend is fixed.
• Serve as a long term source of finance.

Hybrid Instruments

Convertible Bond

• Fixed income instruments with a call option equity.
• Interest rates are lower than interest rates on standard fixed income bonds.
• They bring profits to the company since issuance is quicker and the new capital does not affect the firm’s earnings.
• Beneficial to the investor if the price of the common share is higher than the conversion price.

Secured Premium Notes

• Issued with detachable warrants.
• Redeemable after a period of 4 to 7 years.
• Warrants enable the holder to get equity shares allotted provided the secured premium notes are fully paid.
• Holder can sell the secured premium notes back to the company at par value after the lock in period.

Equity shares with Detachable Warrants

• Holder of the warrant is eligible to apply for the specified number of shares on the appointed date at a predetermined price.
• Warrants are separately registered and traded.
• Issued by companies like Ranbaxy and Reliance in the past.
• Non convertible debentures with detachable warrants are also used.

Derivative Instruments

Futures

• Contract to buy/sell a specific quantity at a future specified date.
• Both parties have a right to transfer the contract by entering into an offsetting futures contract.
• They are traded on the exchange and are standardized in nature.
• Parties have to honour the obligation regardless of what happens to the value in the intervening period.

Forwards

• It is personalised and unique.
• Agreement between two parties to buy/sell at a future date at a price agreed today..
• Traded over the counter.
• They are specific contracts between specific parties and cannot be set off by a future contract