- HDFC securities
- 27 Mar 2023
- Knowledge Centre
Primarily, a capital market is where people, governments, or companies raise capital. It also encompasses the secondary market, where buyers and sellers trade long-term financial securities such as bonds, stocks, and derivatives based on them. It is different from the money market where currencies or money market instruments are traded.
Most of these capital market instruments are traded in designated exchanges that work as a place to bring buyers and sellers together. There are many more market intermediaries that facilitate such trades.
Capital market instruments
In the most primitive form, an instrument is a contract with two people in institutions – that are called buyers and sellers. What is traded in the market are the certificates that work as evidence of that contract.
Below are some of the capital market instruments that are most popular:
Equities
Equities in the capital market refer to shares of companies. It is one of the most traded financial instruments usually traded on a stock exchange. The section of the market where equities are traded is also called the stock market.
The reason investors want to buy equities is that it promises to deliver relatively superior returns than other capital market instruments. If you own an equity share of a company, it means you are a part owner of that company. Thus buying equities is a big part of any asset allocation strategy to create long-term wealth.
You can buy equity or shares of a company primarily in two ways. One is when companies are trying to raise capital, that is, during an initial public offer (IPO) or follow-on public offer (FPO). It forms the primary market. Two, in the secondary market, when those who already hold shares want to sell them.
Equity derivatives
Stock market derivatives are the instruments that derive their value from shares of companies, called underlying. The four most common examples of derivative instruments are forwards, futures, options and swaps. These things mostly concern buying or selling a predetermined number of shares at a predetermined date and price no matter what the price of the underlying is. Given the nature of these instruments, they are the riskiest instruments to trade.
Debt instruments
In order to raise funds without diluting equity, companies issue debt instruments such as debentures or bonds. Governments across the world also issue bonds to raise funds. These instruments are simply loans that a buyer or subscriber of the debt instrument lends to the issuer or seller. Holding a debt instrument does not mean you hold a stake in a company. Further, these instruments can also be traded in the secondary market similar to shares of companies.
Naturally, this means the issuer of the debt instrument has to pay interest to buyers. Similar to a loan taken from a bank, a debt instrument has a predefined tenure that can be from a few days to tens of years. Interest accrued on the instruments is paid periodically usually on a quarterly, semi-annual or annual basis. The interest rate on such instruments is also predetermined.
Keep in mind that debt instruments also carry a certain amount of risk. However, risks on debt instruments are relatively lower than on stock, thus returns are also comparatively lower. The least risky debt instruments are those issued by governments as they are least likely to default on the payment.
REITs and InvITs
Real Estate Investment Trusts (REITs) and Infrastructure Investment Trusts (InvITs) are a type of capital market instrument that lets you invest in physical infrastructure assets – either completed or under construction -- like highways, office buildings or electricity networks. Companies owning these assets issue units of REITs or InvITs that work like shares of a company, ensuring your part ownership of those assets. These units are traded on stock exchanges. Thus, you get the opportunity of capital appreciation as well as receive dividends from profits generated from the underlying assets.
Exchange-Traded Funds (ETFs)
Exchange-Traded Funds (ETFs) are similar to mutual fund that is traded on stock exchanges like any other stock. ETFs invest in a bunch of companies, usually part of a stock market index. They tend to move in tandem with the indices they track. Dividends generated on companies are usually reinvested resulting in the compounding of wealth.
How to invest?
Most financial instruments listed above can be bought in the secondary market. They are listed on BSE and National Stock Exchange (NSE), the two most popular exchanges in India. Government-issued debt instruments can also be bought from the Reserve Bank of India (RBI). They can later be traded in the secondary market on exchanges.
Where should you invest?
The choice of buying any of the financial market instruments should depend on the asset allocation strategy of an individual investor. They should also be aware of the risks associated with each of them, and thus investors should diversify their investments to hedge their risks. They should also be aware of tax liabilities and transaction charges associated with each of these instruments.
