In the capital market, companies raise funds by issuing various financial instruments. These financial instruments/ securities represent a claim on another economic unit’s assets or income stream. These financial claims are held for expected returns. A financial instrument issued under a set of terms and conditions about the payment of interest, dividend to the holder, maturity life, and redemption value. In this article, you will know the types of capital market instruments as well as characteristics.
Types of Capital Market Instruments
The financial instruments can be put into three categories:
1. Direct securities
Direct securities are the primary securities issued by non-financial economic units. The primary securities include. It is one of the types of capital market instruments.
(A) Types of Shares
The company’s shareholders are the company’s owners; therefore, the shares represent ownership securities. There are two types of shares under the Indian Company Act:-
(i) Equity Shares
Equity Shares are part of the company’s share capital which are not preference shares. They are the real owners of the company. They have residual claims on the income and assets of the company.
(ii) Preference Shares
Preference Shares are those shares that have the following two preferences. Therefore a share that does not enjoy both these preferences is an equity share:
- Carries prudential rights regarding dividends at a fixed amount or fixed rate
- It also carries prudential rights regarding capital repayment when winding up or otherwise.
(B) Debenture
A debenture is a document that either creates a debt or acknowledges it. It is issued as a certificate acknowledging indebtedness and under the company’s common real. Debentures are one of a series issued to several lenders. The rate of interest and date of repayment is specified in the debentures. They are issued against a charge on the assets of the company debenture holders have no right to vote in the meeting.
Types of Debentures
i) Bearer debenture
They are payable to the bearer of the instruments. These are negotiable instruments and are transferable by delivery.
ii) Registered debenture
They are payable to the registered holder. Whose register of debenture holders maintained by name appears both on the debentures and in the company?
iii) Secured debenture
Debentures that create a change in the assets of the company are known as secured debentures.
iv) Unsecured debenture
Debentures that are issued without any change on assets are unsecured.
v) Redeemable debentures
Typically debentures are issued on the condition that they shall be redeemed after a claim period. They can, however, be re-issued redemptions.
vi) Perpetual debentures
When debentures are irredeemable, they are called perpetual. Perpetual debentures cannot be issued in India at present.
vii) Convertible debentures
If debenture holders are given the option to convert debentures into equity shares at the stated rate of exchange after a specified period.
2. Indirect Securities
Inventors may not directly invest in shares and debentures of the different companies. They buy the units of funds that hold the various types of securities on behalf of investors, such as units of mutual funds, policies of insurance companies, deposits of banks etc. It is one of the types of capital market instruments. Indirect investing is an alternate route to investing. In the case of indirect investment, the investors let the investment companies do all the work and make all the decisions (for a fee). These investment companies and mutual funds act as financial intermediaries between the investor and the investee.
The primary consideration underlying the attractiveness of indirect securities is that the pooling of funds by a financial intermediary leads to several indirect and derived benefits, e.g., diversification of risk, division of labor efficiencies of size and scale, expert management etc. These financial inter Madeiras collect funds from investors and invest in various securities of different companies. Based on funds collected, they issue units to the investors, known as indirect securities, e.g., units of mutual funds.
3. Derivative Instruments
Derivatives are financial instruments whose value depends upon the value of some underlying assets. Such assets could be tangible such as rice, wheat, oil, cotton or financial investments like equity, debentures or it. It could be intangible such as interest rates or indexes etc. The returns on derivatives are derived from those of assets. Thus the performance of derivatives depends on how the underlying asset performs.
Top 4 Characteristics of Derivatives
- Their value is derived from an underlying instrument such as equity shares or stock index—currency, interest rate, etc.
- They are used as vehicles for transferring risk.
- Derivatives market trading is computerized screen-based trading settled through the stock exchange in cash only.
- Corporations use them to hedge currency risk and inventory risk.