CAPITAL MARKETS & CAPITAL PRODUCTS

capital market is a financial market where debt or equity-backed securities are traded. Capital market is the market for long term investments. The buyers and sellers come to transact in capital market instruments like equity, bonds, debt instruments, debentures, shares, derivatives instruments e.g. forwards, futures, options, swaps, hedging etc.

Many Financial regulators like Securities and Exchange Board of India (SEBI), Bank of England (BoE) and the U.S. Securities and Exchange Commission (SEC) control capital markets to protect investor’s interest against any investment fraud, among other duties.

A capital market types:

  • Primary market – In primary market, new equity or bond issues are issued to investors known as underwriting. The main entities to raise long-term funds in the primary capital markets are:
    • Governments (municipal, local or national) – Bonds
    • Business enterprises – Equity & Debentures
  • Secondary market – In secondary market, existing securities are traded among investors or traders on the stock exchange usually, over-the-counter, or elsewhere. The securities raised from primary market are further traded in secondary market. Entities who raised fund from primary market can sell in secondary market for swift cash flow.

Capital Market Products:

Equity

Equity is share capital issued by the companies to raise capital for business. Investors who subscribe the equity are the shareholders of the company and has rights in decision in the operations of the company to the extent of their proportion. Equity ownership can be obtained through an Initial Public Offer (IPO), a Rights Issue , private placement, or purchase from Stock Exchange.

Bonds

A bond is a debt instrument in which an investor provides loan to an company for a certain period of time at a floating or fixed interest rate. Bonds are issued by companies, municipalities, states and sovereign governments to raise capital and finance many projects and activities. Subscribers of bonds are creditors of the issuer. There are mainly 3 categories of bonds issued in the market are:

  1. Treasury Bonds
  2. Corporate Bonds
  3. Gold Bonds

Preference Shares

Preference shares are similar to equity but rank higher in seniority, compared to ordinary shares, with dividends gets paid out first to shareholders holding them before equity shareholders. In the event of wind up, preference shareholders are paid first from company assets after creditors but before equity shareholders.

Derivative Instruments

Derivatives are the financial instrument which drives its value from underlying assets. These are mainly contracts or trades which are generated from real instruments like equity, debentures etc. The main use of derivatives instruments is to transfer the risk associated with underlying assets.

There are four most common types of derivative instruments.

  1. Forward Contract
  2. Futures Contract
  3. Options Contract
  4. Swaps

Venture Capital Funds

Venture capital fund is capital source which is issued by venture capital firms. They invest in new ventures or an expanding business in exchange for shares in the business. It involves high risk as they mainly invest in startups for seed funding.

Venture capital Funds are critical in addressing the funding requirements of entrepreneurial companies like startups that generally do not have the large size, higher assets, and operating business histories which is important to acquire capital from traditional capital sources like as public issues or banking institutions.

Private Equity Funds

Private equity funds generally invest in high-growth companies for acquiring ownership in equity. These PE funds acquire equity of private companies or those of public companies that go private or de-listed, with a strategy to exit at the right moment. There are various types of private equity firms who makes equity investments and also take role in business activities depending upon the investment types. Passive involvement is quite common with mature or large scale companies who has advanced business models that need capital to expand or restructure their business operations, enter new markets, launching new products or finance an merger or acquisition, while active involvement refers to that the firm plays a direct role in business restructuring the company, operational activities involvement, leadership team reshuffling and providing advice, support, and introductions.

Exchange-Traded Funds (ETFs)

Exchange traded funds are an exchange traded security which tracks an index (i.e. pool of stocks), a commodity or a specific portfolio of assets. The traded security is bought or sold on a trading day on a stock exchange at a market based price just like a share. In case of an index ETFs, its like a collective investment scheme which offers investors a proportionate share in a pool of shares, bonds or assets.

In the case of a commodity ETF, such an ETF invests in real commodities like agricultural goods, natural resources & precious metals i.e. Gold and Silver. It is also possible for a commodity ETF to concentrate on a single commodity, with physical holdings or to invest in futures commodities contracts.

Depository Receipts (DRs)

Depositary Receipts (DRs) are an instrument issued in one country represents an interest in the given underlying assets issued in another country. These are used to raise capital from international market. The underlying securities are mainly held by a Depository Banks. Some of the depository receipts are:

  • American Depository Receipts (ADR)
  • Global Depository Receipts (GDR)

Collective Investment Schemes (CISs)

Collective investment schemes is another capital raising sources where securities offered by a company in which contributions made by the investors are combined and utilized for paying a returns with specific shared investment that has been created for the scheme. Collective investment funds are group assets from individuals and organizations to create a large diversified portfolios.

Real Estate Investment Trusts (REITs)

Real Estate Investment Trusts are kind of capital raising source where pooled investments are designed for investors to benefit from investments made in large-scale real estate enterprises projects. They make an invest in real estate through properties or mortgages and trade on a securities exchange like a simple stock. It provide investors a liquid stake in real estate and mortgage properties.

Asset Backed Securities

Asset-backed securities (ABSs) are capital market product where securities created by bundling the loans like residential mortgage loans, commercial loans or student loans and creating securities which are backed by return on those assets, which later on are sold to investors. For investors, its an asset-backed securities alternative to investing in corporate debt. They are mainly used to finance large projects like roads, power, energy, ports, railways and many other projects.

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