4. CAPITAL MARKET INSTRUMENTS
INTRODUCTION
What is capital market?
Capital market is the segment of financial market that dealing with
effective channeling of medium to long term funds from surplus to deficit
units.
Normally the process of transfer this channeling is through documents or
certificates; thus is showing evidence of investments.
5. CAPITAL MARKET INSTRUMENTS
PRIMARY ROLE
The primary roles of capital market is to raise long term funds for government,
banks, and corporation while providing platform for the trading of securities.
This fund raising is regulated by the performance of stocks and bonds market
within the capital market
The members or organizations of the capital market may issue stocks and bonds
in order to raise funds. Investors can then invest in the capital market by
purchasing those stocks and bonds
6. CAPITAL MARKET INSTRUMENTS
REGULATION OF CAPITAL MARKET.
Every capital market in the world is monitored by financial regulators and
their respective governance boards.
The purpose of such regulation is to protect investors from fraud and
deception.
Financial regulatory boards are also charged with minimizing financial
losses, issuing licenses to financial service providers, and enforcing
applicable laws.
7. CAPITAL MARKET INSTRUMENTS
• The Influence of Capital Market on International Trade.
Capital market investment is no longer limited to the boundaries of a
single nation.
Today’s corporations and individuals are able, under same regulations, to
invest in the capital market of any country in the world. Investment in
foreign capital market has caused substantial development to the business
of international trade.
8. CAPITAL MARKET INSTRUMENTS
• NATURE OF CAPITAL MARKET
It has two segments
It deals with long term securities.
It helps capital formation.
It helps in creating liquidity.by dealing with capital market you can create
liquidity of your asset easily
It performs trade off functions.
9. TYPES OF CAPITAL MARKET
• There are two types of capital market.
• Primary market
• Secondary market
• Primary market: The primary market deals with the trading of newly issued securities
The roles of primary market are as follow:
Origination
Underwriting
Distribution
10. FEATURES OF PRIMARY MARKET
• It related only with new issues
• It has no particular place
• It has various methods of float capital, such as Public issues, Offer for
sales, Private placement, Right issue and Electronic –initial public offer.
• It come before secondary market
11. SECONDARY MARKET
•Secondary market is also called after market is the financial market
in which previously issued financial instruments such as stock, bonds,
option and future are bought and sold.
• The main function of secondary market :securities are sold by and
transferred from one investor or speculator to another. It is therefore
important that the secondary market be highly liquid (originally, the only
way to create this liquidity was for investors and speculators to meet at a
fixed place.
12. FEATURES OF SECONDARY MARKET
• It create liquidity.
• It come after primary market.
• It has particular place.
• It encourage new investments.
13. CAPITAL MARKET INSTRUMENTS
It includes;
• Equity instruments ( common stocks)
• Debt instruments
• Insurance instruments.
• Hybrid instruments
• Derivatives
14. EQUITY INSTRUMENTS
•Equity is used in accounting in several ways. Often the word equity is
used when referring to an ownership interest in a business. Examples
include stockholders' equity or owner's equity
• In the capital market equity is used as a source of finance (capital)
• When the company wants to raise funds it can issue common stock or
preference shares.
15. EQUITY INSTRUMENTS
• The main types of equity are :
• Common stock: A security that represents ownership in a corporation.
• When the company issue common stock they gives shareholder to own some part
of company ownership.
• Holders of common stock exercise control by electing a board of director and
voting on corporate policy.
• In the event of liquidation, common stockholder have rights to a company's
assets only after bondholder, preferred shareholders and other debtholders have
been paid in full.
16. COMMON STOCKS
• If the company goes bankrupt, the common stockholders will not receive
their money until the creditors and preferred shareholders have received
their respective share of the leftover assets.
• This makes common stock riskier than debt or preferred shares. The
upside to common shares is that they usually outperform bonds and
preferred shares in the long run.
17. PREFERENCE SHARES
• The holder of preference share also own some percentage of the company
but cannot participate in anything to the company.
• Holder of preference share has the claim of the company asset and earning
of the company .
• Normally has the first priority if there is any dividend payment than
common stock holder.
• The main benefits to owning preference shares are that the investor has a
greater claim on the company’s asset than common stockholders.
18. PREFERENCE SHARE (PREFERRED
SHARES)
• Preferred shareholders always receive their dividends first and, in the event the
company goes bankrupt, preferred shareholders are paid off before common
stockholders.
• In general, there are four different types of preferred stock.
• Cumulative preferred stock
• Non cumulative preferred stock
• Participating preferred stock
• Convertible preferred stock
19. CUMULATIVE PREFERRED STOCKS
• A preferred stock will typically have a fixed dividend yield based on the
per value of the stock. The dividend usually is paid out at set of interval,
usually quarterly to preferred stock.
• If a company runs into some financial problems and is unable to meet all
of its obligations, it will likely suspend its dividend payments and focus on
paying the business-specific expenses. If the company gets through the
trouble and starts paying out dividends again, it will first have to pay back
all of the dividends that are owed to preferred shareholders.
20. NON-CUMULATIVE PREFERRED STOCKS
• A type of preferred stock that does not pay the holder any unpaid or omitted
dividends.
• If the corporation chooses to not pay dividends in a given year, the investors does
not have the right to claim any of those forgone dividends in the future.
Example XYZ Company chooses not to pay its $1.10 annual dividend to its cumulative preferred stockholders. In this
case, these shareholders do not receive the dividend this year, but they are entitled to collect this dividend at some point in
the future. If the preferred shares mentioned above were noncumulative, the shareholders would never receive the missed
dividend of $1.10. This example illustrates why a cumulative preferred share is worth more than a noncumulative preferred
share.
21. PARTICIPATING PREFERRED STOCKS
• A type of preferred stock that gives the holder the right to receive dividends
equal to the normally specified rate that preferred dividend receive as well as an
additional dividend based on some predetermined condition.
• The additional dividend paid to preferred shareholders is commonly structured to
be paid only if the amount of dividends that common shareholders receive
exceeds a specified per-share amount.
• Furthermore, in the event of liquidation , participating preferred shareholders can
also have the right to receive the stock's purchasing price back as well as a pro
rata share of any remaining proceeds that the common shareholders receive.
22. PARTICIPATING PREFERRED STOCKS
• Example: For example, suppose Company Z issues participating preferred shares with
a dividend rate of $1 per share. The preferred shares also carry a clause on extra
dividend for participating preferred stock, which is caused whenever the dividend for
common shares exceeds that of the preferred shares.
• If, during its current quarter, Company Z announces that it will release a
dividend of $1.05 per share for its common shares, the participating
preferred shareholders will receive a total dividend of $1.05 per share
($1.00 + 0.05) as well
23. CONVERTIBLE PREFERRED STOCKS
• Preferred stock that includes an option for the holder to convert the
preferred stock into a fixed number of common shares, usually any time
after a predetermined date.
• Most convertible preferred stock is exchanged at the request of the
shareholder, but sometimes there is a provision that allows the company
(or issuer) to force conversion.
• The value of convertible common stock is ultimately based on the
performance of the common stock.
24. DEBT INSTRUMENTS
• A paper or electronic obligation that enables the issuing party to raise
funds by promising to repay a lender in accordance with terms of a
contract. Types of debt instruments include notes, bonds, certificates,
mortgages, leases or other agreements between a lender and a borrower.
• Debt instruments are a way for markets and participants to easily transfer
the ownership of debt obligations from one party to another
25. DEBT INSTRUMENTS
• A debt instrument is used by government or organization to generate funds for
longer duration.
• The relation between person who invest in debt instrument is of lender and
borrower .
• This gives no ownership right.
• A person receives fixed rate of interest on debt instrument.
• A debt instrument is used by either companies or governments to generate funds
for capital-intensive projects. It can obtained either through the primary or
secondary market.
26. TYPES OF DEBT INSTRUMENTS
There are many kinds of debt instruments among of them are as follow.
Debenture.
Bond
Government bond
Corporate bond
Convertible bond
Loan
Mortgages.
27. DEBT INSTRUMENTS
• Debt instrument or debt financing allows you to pay for new buildings,
equipment and other assets used to grow your business before you earn the
necessary funds.
• This can be a great way to pursue an aggressive growth strategy,
especially if you have access to low interest rates.
• Relative to equity financing, you also benefit by not hand over any
ownership or control of the business
28. DEBT INSTRUMENTS
• On the other hand of debt financing is that you have to repay the loan, plus
interest. Failure to do so exposes your property and assets to repossession
by the bank.
• Debt financing is also borrowing against future earnings. This means that
instead of using all future profits to grow the business or to pay owners,
you have to allocate a portion to debt payments. By Misappropriation of
debt can severely limit future cash flow and stifle growth.
29. HYBRID INSTRUMENTS
• A single financial security which combines two or more different financial
instruments.
• The most common type of hybrid security is:
• convertible bond: which have features of an ordinary bond but is heavily
influenced by the price movements of the stock into which it is
convertible. Normally the owner of convertible bond have the right to
convert convertible bond to share (common stock) in the issuing company
or cash of equal value.
30. HYBRID INSTRUMENTS
• Issuing convertible bonds is one way for a company to minimize negative
investor interpretation of its corporate actions. For example, if an already
public company chooses to issue stock, the market usually interprets this
as a sign that the company's share price is somewhat overvalued. To avoid
this negative impression, the company may choose to issue convertible
bonds, which bondholders will likely convert to equity.
• From the investor's perspective, a convertible bond has a value-added
component built into it; it is essentially a bond with a stock option hidden
inside.
31. HYBRID INSTRUMENTS
• Thus, it tends to offer a lower rate of return in exchange for the value of
the option to trade the bond into stock.
• Furthermore, another popular type of hybrid security is :
• convertible preference share : which pay dividends at a fixed or floating
rate before common stock dividends are paid and can be exchanged for
shares of the underlying company's stock.
32. HYBRID INSTRUMENTS
• Each type of hybrid security has unique risk and reward characteristics.
• When we look from convertible bonds if offer greater potential for appreciation
than regular bonds, but it pay less interest than compared to other bonds, instead
of that it still face the risk that the underlying company could perform poorly and
fail to make coupon payments or not be able to repay the bond's face value at
maturity.
• On other side convertible preference share offer greater income potential than
regular securities, but can still lose value if the underlying company
underperforms.
33. INSURANCE INSTRUMENTS
• Is a financial instruments whose values are driven by insurance loss
events. Those such instruments that are linked to property losses due to
natural catastrophes represent a unique asset class, the return from which
is uncorrelated with that of the general financial market.
• Insurance companies are in the business of assuming risk for individuals
and institutions.
• They manage those risks by diversifying over a large number of policies,
perils and geographic regions.
34. INSURANCE INSTRUMENTS
• There are two important ways insurers profit in this business.
One is by selling portfolios of insurance policies grouped into packages,
to interested investors. The risk from low severity, high probability events
can be diversified by writing a large number of similar policies. This
reduces an insurer’s risk because should a policy default, then the loss is
shared between a large numbers of investors.
35. INSURANCE INSTRUMENTS
• The second way insurers profit on policies is by re-insuring them through
other insurers. A reinsurance policy would allow a second insurer to share
in the gain and potential loss of the policy, much like an investor. The
secondary insurer would share invested interest and risk. The reinsurance
of policies offers additional risk capital and high returns for the policy
originator, and minimizes their liability, while also providing high returns
for any secondary insurer.
36. CONCLUSION
• The lack of an advance and vibrant capital market can lead to under
utilization of financial resources. The developed capital market also
provide access to the foreign capital for domestic capital industry.
• Thus capital market definitely play a constructive role in the overall
development of an economy.
