INSTRUMENTS TRADED IN THE CAPITAL MARKET

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The capital market is the marketplace for medium to long-term financial instruments 

The capital market trades a variety of medium and long-term financial securities. These instruments can be grouped into four main headings: Debt instruments, common stocks, derivatives, and preference shares.

Let's look at each of them in more detail.

Debt instruments

Debt instruments are instruments that companies and governments use to raise required finance. They are available in both the primary and secondary markets.

Debt instruments are one of the safest forms of investment in the capital market because they are risk-free. Because of this, it attracts lesser returns as compared to other types of instruments in the capital market.

There are four types of debt instruments, viz:

1. Sovereign bonds: These are debt instruments issued by the federal government to fund government spending.

They are issued by the federal government to raise funds for capital expenditures such as infrastructure construction. They are also called government bonds.

2. State bond: These are debt instruments issued by the state government to support their spending

3. Municipal bonds: Municipal bonds are issued by local governments to fund their day-to-day operations and capital projects. It is commonly referred to as munis.

4. Debentures: These are unsecured debt instruments that repay a specified sum of money plus interest to its holders at maturity.

The debenture is unsecured in the sense that it is not backed by any collateral. They are only documented in an indenture.

Common stocks (Equity instruments)

These are issued by corporate entities and can be purchased in the primary or secondary market.

They represent a form of ownership of a corporation. Holders of common stocks, like other business owners, have the right to vote and hold positions in the company.

Common stocks are one of the most popular capital market instruments. This is because they attract higher returns and are held in perpetuity (except if the company liquidates).

Preference shares

This is similar to common stock. The major difference is that its payment takes precedence over that of common stockholders.

To put it in another way, preference shareholders are first paid dividends before common stockholders are paid.

In the event of a liquidation, the interests of preference shareholders take precedence over the interests of common stockholders. 

Preference shares are commonly referred to as hybrid instruments since they have the characteristics of both equity and debt securities.

Preference shares are equity instruments because they are similar to common stocks.

Preference shares are also debt instruments because they do not give their holders voting right like common stocks and they have a dividend payment structure that is similar to that of interest (coupon) paid on bonds.

Derivatives

As its name suggests, derivatives are financial instruments that are derived from other instruments.

In other words, derivatives are financial instruments that are linked to other financial instruments.

Because they are linked to other financial instruments, the price and risk of the derivative are influenced by those instruments.

The derivatives will be affected if the price of the other instrument changes. Some common derivatives are mortgage-based securities, futures, options, swaps, rights, and exchange-traded funds.

1. Mortgage-based securities: These are claims on the cash flows from mortgage loans. They are most common with residential properties.

Mortgage-backed securities get their final value from the principals and payments on the loans in the pool, which can be divided into several classes based on the riskiness of the different mortgages.

2. Futures: These are financial contracts in which two parties (the buyer and the seller) agree to trade a commodity or financial instrument at a future date and price.

The quantity and quality of the object to be traded, as well as the form of delivery and payment, will be adequately specified in a futures contract.

3. Options: These are financial derivatives that give the buyer the right, but not the obligation, to buy (call) or sell (put), financial instruments at a predetermined price (called the striking price) before or on a certain date ( called the exercise date)

4. Swaps: As its name implies, a swap is a derivative that allows two parties to exchange financial instruments, cashflows, or payment periods.

It's simply a two-party exchange of financial instruments or cash flows.

5. Rights: This is an invitation to existing shareholders to purchase a pro-rata allocation of additional shares at a certain price and within a specific time frame.

Rights allow existing shareholders to acquire additional shares in an allocated ratio. Rights are the most common financial derivatives in Nigeria.

6. Exchange-traded funds (ETFs): These are investment funds that may be exchanged on a stock exchange. That is, they can be purchased and traded in the same way that stocks can.

instruments traded in the capital market
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