Understanding Various Financial Instruments in Capital Markets
Published by Sharekhan Education | May 22, 2024
Financial instruments are contractual agreements outlining the relationship between two parties, where one party is indebted to the other. These agreements function as tradable assets or investment tools. Examples include stocks, derivatives, bonds, exchange-traded funds (ETFs), and mutual funds, all of which are traded on stock markets. Securities can generally be divided into two groups: equity-based, such as stocks representing ownership in a company, and debt-based, like bonds and loans signifying an investor’s loan to a borrower. Let us discuss these various types one by one.
Stocks/Equities
Equities represent one of the most favoured financial assets in capital markets. While they hold the promise of substantial returns in a brief period, they are equally characterized by their volatility. Essentially, shares signify ownership stakes in companies, with investors acquiring them with the intention of selling at a profit, typically by purchasing at lower prices and selling at higher ones. Trading of shares occurs on stock exchanges like National Stock Exchange (NSE) and Bombay Stock Exchange (BSE). Investors foresee growth and value escalation over time, thereby reaping benefits from capital gains and dividends.
Debt Securities
Corporations and governments issue debt securities to secure funds for their expansion or developmental endeavors. Investing in these securities enables investors to accrue interest from the issuer. Unlike equity investments, holding debt instruments does not grant ownership rights in the issuing entity. Bonds, which promise to repay a specified interest amount by a predetermined date, deem safer investments compared to other instruments.
Mutual Funds
Mutual funds collect funds from numerous investors and allocate them across a diverse array of assets, including stocks, bonds, and various other asset types. The primary aim of mutual funds is to yield risk-adjusted returns for investors over an extended period. Fund managers task themselves with making investment choices to fulfill the fund’s investment objectives.
Exchange Traded Funds (ETFs)
Exchange-traded funds (ETFs) operate akin to mutual funds but are just like individual stocks. Their design aims to mirror the returns of underlying indices, sectors, commodities, or asset classes almost identically.
An investor ought to select a financial instrument based on their tolerance for risk and their anticipated returns.
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