Capital Market Instruments, Examples and Types

Capital market instruments include stocks, bonds, equities, etc. A forum is being created where these parties can exchange securities. Here, different types of financial instruments are traded by different entities. These instruments will be explained in the latter part of this article.

What is a capital market?

A capital market is a market where long-term securities are bought and sold such as stocks and bonds. These long-term securities last for over a year. In other words, capital market transactions take place between buyers and sellers of long-term securities. Capital markets help in channeling surplus funds from savers to institutions and these institutions then invest them into productive use. It is individuals such as individuals and institutions that participate in the buying and selling. Capital market stakeholders include banks, industry trade groups, and other financial intermediaries.

The components of capital market comprise primary and secondary markets. While the primary capital market deals with the trading of the new issue of stocks, the secondary capital market has to do with the exchange of existing or second-hand securities between investors.

Capital markets look towards the improvement of transactional efficiencies as suppliers and those in need of capital are brought together.

Angels fill a significant gap in the capital market. This is because they are the major source of capital thereby facilitating capital formation. Angel investors are individuals that make capital available for business start-ups usually in exchange for convertible debt or ownership equity. It is in this context that funds are being transferred from savers to institutions or businesses that invest them into productive use.

Capital Market Solutions provides consultancy and advisory services to financial services companies with an emphasis on Capital Markets. We provide solutions for Investment Banks, Exchanges, Broker-Dealers, Hedge Funds, Asset Managers, Trading and Clearing Firms.

Capital market definition

The capital market is the market for trading long-term securities such as bonds and equities. Stocks and bonds are capital market security examples. It is an exchange system platform where the transfer of capital from investors who desire to employ their excess capital to businesses that require capital to finance different projects or investments.

From the definition above, capital markets are made up of suppliers and users of funds. the suppliers include households (through the savings account they hold with banks), pension and retirement funds, life insurance companies, charitable organizations, and non-financial companies that generate surplus cash, etc. On the other hand, the users of funds that are being distributed on the capital market include home purchasers, motor vehicle purchasers, non-financial companies, governments financing infrastructure investments, operating expenses, etc. Capital market firms handle financial and banking services for clients and customers.

The capital market authority laws exist in order to regulate and develop the capital market. This helps in regulating the issuance of securities as well as the supervision of its transactions. In other words, the capital market authority is charged with the responsibility of protecting the interests.

A global capital market interlinks different investment exchanges all over the world which enables individuals and entities to buy and sell financial securities on the international level. With this, capital market expectations are essential in the formulation of strategic asset allocation. For instance, if the investment policy statement of an investor specifies and defines eight classes of permissible assets, there will be a need for the investor to formulate long-term expectations with regard to each of those asset classes.

Capital market theory

The theory of capital market tries to explain and predict the progression of capital and sometimes financial markets over time based on one or the other mathematical model. It is a generic term for the analysis of securities. When it comes to trade-offs between the returns that investors sought and the inherent risks that are involved, the theory is a model that seeks to price assets that are most commonly shares. In the study of the capital market theory, issues like the role of the capital market, initial public offerings, major capital markets worldwide, the role of securities, and capital market regulatory requirements, the role of the government treasury, etc, are being addressed.

Capital market history

Through a financial exchange system in Belgium, the formation of the first capital markets took place in the 14th and 15th centuries. Prior to this, similar types of markets were formed in french, Italian, and German towns in the 13th century. At that time, this was the center of international trade and this early market saw mostly promissory notes and bonds being traded and issued which was a start.

In the early 17th Century, the Dutch East India Company arose which still has the highest market capitalization. It was the first publicly-traded company whose trade took place on the Amsterdam Stock Exchange. This brought about massive financial innovation. Also during this time, the first derivatives, dividend distributions, and futures trading were seen, and short selling also occurred.

When the United States captured this and was able to put similar concepts into action, the first stock exchanges were being established and the Philadelphia Stock Exchange was the first in the nation. The NYSE quickly took on some steam shortly after the Steam pun as this happened in the course of the railroad boom in the United States. However, one can note that there is a common sentiment in the present day that the technology sector is overweight in the public markets.

Characteristics of capital market 

  1. The structure of capital market
  2. Security as a basic requirement
  3. The role of brokers and dealers
  4. Competition

The capital market is the primary source of raising finance for the funding of any business activities. Therefore for the market to be effective, it must possess these characteristics. They are explained below thus;

The structure of capital market

As stated earlier, the capital market comprises primary and secondary markets. In the primary market, the initial public offer of securities takes place. This takes place through issuing houses and underwriters. In the secondary market, all subsequent trading on the securities that exist takes place. There exist financial regulators and agencies such as the Securities and Exchange Commission in the secondary market that play a major role in regulating their operations.

Security as a basic requirement

For any category of investment to make a profit, the basic requirement is security. These securities are financial instruments that carry all relevant information with regard to the underlying assets, liabilities, income, and expenses.

The role of brokers and dealers

Brokers and dealers have an important role they play in the capital market. They serve as middlemen which implies that they buy and sell securities for their customers. This set of people generates their profit by collecting brokerage fees. The brokerage fee is a small percentage of the overall value of the transaction.

Competition

Competition is a key factor that exists among the market players in the capital market. It is important for an active and competitive market to be in place because it ensures that the buyers and sellers get the best price for their investment. A proper system of transfer of ownership of securities must exist in order to enable them to change hands.

Types of capital market

  1. Primary Market (New issue market)
  2. Secondary Market

The above-mentioned are the components of the capital market. They are explained below;

Primary market

Another name for the primary market is the new issue market. Here, the sales of new securities take place, that is, securities are bought and sold for the first time. It is the company that issues new securities. The primary capital market makes a direct contribution to capital formation because here, the company goes directly to investors and utilizes these funds for investment in buildings, plants, machinery, etc.

The primary market does not comprise finance that takes the form of loans from financial institutions. This is because when there is an issuance of loans from financial institutions, it implies the conversion of private capital into public capital, and this conversion process is referred to as going public. Equities, debentures, and bonds are common securities that are traded in the primary market. Both new and existing companies can raise capital on the new issue market.

The basic function of the primary market is the facilitation of the transfer of funds from willing investors to the entrepreneurs that are setting up corporate enterprises or expanding their businesses. Aside from assisting corporate enterprises in securing their funds, the primary market channels the flow of savings of individuals and others into investments.

The issuing companies and the investors represent the market forces, that is supply and demand. However, the organization of the primary market is incomplete without specialized agencies, intermediaries, institutions, etc. They promote the issues of new securities and help in selling, transferring, underwriting, etc. These agencies include financial institutions, brokers, underwriters, etc.

The primary market directs the flow of savings into long-term investments which is of great importance to the economic growth and industrial development of a country. The availability of financial resources to corporate enterprises is dependent upon the status of the country’s primary market to a great extent.

Methods of security floatation in the primary market

Security floatation is a situation whereby new securities are being issued for raising funds. Below are the methods of security floatation in the primary market.

  1. Public issue through a prospectus
  2. Offer for sale
  3. Private placement
  4. Right issue (for existing companies)
  5. Electronic initial public offers (e-IPOs)
Public issue through prospectus

Here, the company issues a prospectus to give information to the general public as well as to attract them. In a prospectus, the company gives details with regard to the purpose of raising funds, the company’s past financial performance, background, and future prospects of the company. It is the information in the prospectus that helps the general public to have knowledge with regard to the company’s risk and earning potential. According to this information, the public decides whether to invest or not in the company. Through IPO, companies will be able to approach a large number of persons as well as the public at large. In some cases, the company can involve intermediaries such as brokers, bankers, and underwriters to raise capital from the general public.

Offer for sale

Through this method, the company offers new securities to the general public but this does not take place directly. Here, an intermediary buys a lot of securities from the company. The intermediaries are generally the firms of brokers. Here, the sale of securities takes place in two steps. The first step is when the company issues securities to intermediaries at face value. The second step is when the intermediaries issue securities to the general public at higher prices so they can earn a profit. This method saves companies from the formalities and complexities of issuing securities directly to the public.

Private placement

Under the private placement method, the company sells securities to an intermediary at a fixed price. The second step taken is for intermediaries to sell these securities. however, they do not sell these securities to the general public, they sell to selected clients at a higher price. The issuing company issues a prospectus that gives details about its objectives and future prospects so that these reputed clients would prefer to buy the securities from the intermediary. Here, the intermediaries issue securities to selected clients such as general insurance, etc.

The private placement method is cost-saving because the company escapes the expenses of underwriter fees, manager fees, agents’ commission, listing the name of the company on the stock exchange, etc. Small and new companies prefer this method since they cannot afford to raise from public issue.

Right issue (for existing companies)

The right issue is the method in which a company issues new shares to existing shareholders. Because it is the pre-emptive right of shareholders that the company has to offer them the new securities before subscribing to outsiders, it is referred to as the right issue. Each shareholder is entitled to subscribe to new shares in the proportion of shares he is already in possession of. Under the Companies Act 1956, a right issue is mandatory. The stock exchange does not give room for companies to go for a new issue without giving pre-emptive rights to shareholders. This is because if the company makes a new issue directly to new subscribers, there is a tendency for the existing equity shareholders to lose their share in capital and control of the company. That is, their equity will be watered. So in order to stop this, it is compulsory for existing companies to hive pre-emptive or right issues.

Electronic initial public offers (e-IPOs)

This is a new method of issuing securities through an online system of the stock exchange. Here, it is necessary for companies to appoint registered brokers for the purpose of the acceptance of applications and the placement of orders. It is necessary for the company issuing security to apply for the listing of its securities on any exchange aside from the exchange it has offered to its security earlier. Through different intermediaries, the manager coordinates these activities.

Secondary market (stock exchange)

The secondary market is a market where existing securities are bought and sold, that is, second-hand securities are bought and sold. Here, the company does not directly issue securities to investors. Existing investors sell the securities to other investors. There will be times in which the investor will be in need of cash and another investor will want to buy the shares of the company as he was unable to get directly from the company. In this case, both investors will meet in the secondary market and exchange securities for cash through an intermediary known as a broker.

In the secondary market, market companies do not get any additional capital. This is because the trading of securities takes place between investors only. There is directly no capital formation although the secondary market indirectly contributes to capital formation by providing liquidity to securities of the company. If secondary markets were not in existence, then investors would get back to their investments only after the redemption period is over or at the dissolution of the company. This implies that the investment will be blocked for a long period of time. With the presence of secondary markets, it is possible for investors to convert their securities into cash whenever they wish to. Also, investors have the chance to make profits as the trading of securities takes place at market price which is generally greater than the original price of securities. Because of the liquidity that the secondary market offers, even those investors who want to invest for a small period of time are encouraged to invest in securities. This is because there is an option of selling securities at their own convenience.

Certainly, investors want liquidity for their investments. With the stock exchange or secondary market, it is easy for them to sell their securities whenever they are in need of cash. There is also a need for a place to exist where securities will be bought and sold for others who want to invest in new securities.

Stock exchanges make provision for such a place where securities of different companies can be bought and sold. It is a body of persons whether they are incorporated or not, formed with the aim of providing help, regulating, and controlling the business of buying and selling securities. They are organized and regulated markets meant for various securities that the corporate sector and other institutions issue. As it has been emphasized, the stock exchange allows free sales and the purchase of securities.

Primary market vs secondary market

Primary and secondary markets are the components of the capital market and serve great importance. Let us look at the areas they differ.

As we have seen earlier, a company publicly sells new securities, that is for the first time such as an initial public offering (IPO). This is the reason why the primary market is called the new issues market. On the other hand, the secondary market involves the trading of existing or second-hand securities.

While a company sells securities to investors in the primary market, securities are traded between investors in the secondary market and it includes venues that are overseen by a regulatory body such as the Security Exchange Commission (SEC)

While issuing companies have a part to play in the primary market, they do not play any part in the secondary market.

In the primary market, funds flow from savers to investors, that is, the primary market directly promotes capital formation. On the other hand, the secondary market enhances the liquidity of shares, in other words, it indirectly promotes capital formation. We can say that while the primary market directly promotes capital formation, the secondary market indirectly promotes capital formation.

While in the primary market, only buying of securities takes place without selling, In the secondary market, both buying and securities take place on the stock exchange.

In the primary market, the management of the company determines prices. On the other hand, it is on the basis of demand and supply of securities that prices are determined in the secondary market.

The primary market does not have a fixed geographical location whereas the secondary market is located at specific places only.

Functions of capital market

  • Economic growth
  • Promotes saving habits
  • Stable and systematic security prices
  • Links savers and investors
  • Capital formation
  • Provision of investment avenues
  • Minimizes transaction cost and time
  • Returns on investment

The importance of capital market to an economy is explained below;

Economic growth

A function of a capital market is to accelerate the process of economic growth. It is a reflection of the economy’s general condition. The capital market facilitates the proper allocation of resources from those with surplus capital to those individuals and firms that need capital. With this, we can say that it helps in expanding both trade and industry of both public and private sectors thereby amounting to balanced economic growth. In other words, economic growth and development speed up as funds are being provided among different sectors in the economy continuously. Funds are made available for infrastructural development. Developing infrastructure requires huge funds in a country. Through the capital market, the long-term financial requirements of different businesses are being met. In turn, this improves the productivity of the economy as employment is being generated as well as the development of infrastructure.

Promotes saving habits

The development of capital markets, the banking institutions, and the taxation system provide facilities that in turn make provision for investors to save more. If capital markets were absent, investors might have invested in unproductive assets or even indulge in unnecessary spending.

Stable and systematic security prices

Aside from the mobilization of funds, capital markets help in the stabilization of stock prices. When there is a decrease in speculative activities and capital is being provided to borrowers at a lower interest rate, this helps to stabilize the prices of securities. The capital market continues to monitor the trading of securities. It keeps watching over the process that takes place in order to avoid unproductive and speculative activities. They provide funds at standard and minimum interest rates to the borrower thereby helping in the stabilization of security prices in the economy. In other words, the capital market ensures that the price of an asset is accurate.

Links savers and investors

The capital market acts as an intermediary between those who have excess funds and the ones in need of fund of funds. Here, the ideal lying resources are being channeled to more productive sources where they can generate income as well as increase productivity. It mobilizes the savings of people by directing and guiding them to productive investment. These investments make provision for regular income and growth for the investors.

Capital formation

The capital market plays an efficient role in an economy’s capital formation. Here, the financial needs o different sectors are being fulfilled and catered to by the provision of sufficient funds timely. It facilitates the transfer of funds from ideal lying sources to more productive and development sources. Through the capital market, the savings of people are being mobilized through investments. It then lends that money to fund large development projects in the economy. With this, the overall fund requirement is being fulfilled and it helps in adding to the stock capital that exists in the economy.

Provision of investment avenues

Through the capital market, different long-term investment avenues are being made available to the investors. As earlier stated, it has to do with the trading of long-term securities thereby raising and lending money for long periods. Also, good interest rate options are being offered to the people for investing their surplus funds. Here, the system encourages people to invest their funds and earn regular income in the form of interest. In other words, the capital market ensures that sufficient funds are available in the economy. It is a liquid market because buyers and sellers of securities continue to be available there. With this, funds circulate across different sectors of society thereby easing the adequate availability of funds.

Minimizes transaction cost and time

Because the capital market facilitates the trading of long-term securities, the overall cost and time involved in the whole process of trading is being reduced. The entire trading process takes place electronically through automated systems and programs thereby speeding up the entire process.

Return on investment

Enough financial instruments exist in the capital market to suit any type of investor, this is whether they would prefer a high level of risk or a low level of risk. This implies that there is something for everyone. Simultaneously, the capital market provides an opportunity for investors to enhance their yield on their capital. Savings accounts offer little interest especially when we compare it to the yields on the majority of stocks. Therefore, investors can have the opportunity to make a higher rate of returns, however, there is an element of risk too.

What is capital market instrument?

Capital market instruments are the securities that are being traded in the capital market.

Types of capital market instruments

  • Bond markets
  • Debt capital market instruments
  • Equities
  • Preference shares
  • Derivatives

Capital market instruments include the above-mentioned.

Bond markets

A bond is one of a capital market instruments examples; it is very diverse in its offerings. This is the reason why most trades in this market take place Over the Counter (OTC). There are many types of bonds, however, let us look at some below;

  1. Corporate bonds – investment-grade
  2. Corporate bonds – Junk bonds
  3. Foreign bonds
  4. Municipal bonds
  5. Treasury bonds
  6. Zero-coupon bonds

Corporate bonds – investment-grade

Corporate bonds simply refer to businesses borrowing money in exchange for a bond at a set interest rate. This usually takes the form of short-term bonds with a maturity period of five years or less, immediate bonds with a maturity period of five to twelve years, and long-term bonds with a maturity period of over twelve years. To be more specific, investment-grade bonds are those that are categorized for large businesses that are not likely to default. They carry more risks than government bonds but are safer than junk bonds.

Corporate bonds – Junk bonds

This offers a higher yield than other types but also offers the highest level of risk. The reason for this is that the companies offering these bonds are either small or unreliable. This implies that investors have a low likelihood of receiving their initial investment back. It is a good means for small to medium businesses to obtain capital and grow because it gives them room to access the credit they may not access otherwise.

Foreign bonds

A foreign entity issues foreign bonds within a domestic country in a local currency. For example, a Ukrainian firm may want to raise some capital in the UK since it is not able to raise it in the Ukrainian capital markets. This can pose a greater risk to the foreign entity due to the fluctuation of currencies. However, there is an avenue to capital that may not be available in its own market. Also, investors have the opportunity to diversify their portfolios to reduce their exposure to economic fluctuations.

Municipal bonds

A municipal bond is different from a government bond in the sense that it is the local government that issues them or one of its agencies instead of the federal government. Generally, these bonds are safe but are riskier than Treasury bonds. They can be popular because they come in tax-exempt versions with the investment funding for local infrastructural projects which may include bridges, new parks, or bridges.

Treasury bonds

Treasury bonds also known as government bonds are issued by the federal/central government over a set period of time usually above ten years. The amount of interest they earn is small, below the market average. this is because of the low risk associated with such.

Zero-coupon bonds

These are bonds that are sold on the market at a steep discount because there is no interest due until it expires. However, its value essentially gains over time. Usually, these bonds are inflation-indexed in order to make sure that the bond owner maintains its purchasing power over time.

Debt capital market instruments

Companies snd governments use a debt capital market instrument to generate funds for capital intensive projects. They can obtain this either through the primary or secondary market. Here, the relationship of this type of instrument ownership is the borrower-creditor relationship. It does not necessarily imply ownership in the borrower’s business. this contract lasts for a specific duration and the payment of interests takes place at specific periods as it is being stated in the contract of agreement. The payment of the principal sum invested takes place at the expiration of the contract and the interest is paid either quarterly, semi-annually, or annually. Here, the interest stated in the contract (trust deed) can either be fixed or flexible. In this category, its tenure lasts between three to twenty-five years. Most times, investment in this instrument is risk-free and yields lower returns unlike other instruments traded in the capital market. In the event of a company’s liquidation, investors that fall in this category get top priority.

Equity capital market

Equity is also called common stock and it is issued by companies only. Also, it is obtainable either in the primary or secondary market. Investment in this context translates to ownership of the business as the contract stands for an endless duration except if it is being sold to another investor in the secondary market. Therefore, the investor has certain rights and privileges which include the right to vote and hold a position in the company. The investor in debts may have entitlement to the interest which must be paid. The equity holder receives dividends which will probably be declared or not. This financial instrument possesses a high-risk factor and yields higher returns when successful. However, the holders of this instrument usually rank bottom on the scale of preference, that is, they are not placed on top priority in the event of the company’s liquidation. this is because they are considered owners of the company.

Preference shares

Corporate bodies issue preference shares and the investors rank second after the holders of bonds on the scale of preference. The financial instrument has the features of equity in the sense that when a company calculates the authorized share capital and paid-up capital, it adds them to the equity capital to arrive at the total. We can treat preference shares as a debt instrument as they do not confer the right of voting on its holders. Also, the holders of preference shares have a dividend payment structured like interest paid for the issue of bonds.

Preference shares may be redeemable, irredeemable convertible, and irredeemable non-convertible. For the redeemable preference shares, the payment of the principal sum is made at the end of a specified period. For the irredeemable convertible preference shares, when it matures, the principal sum that the company returns to the investor is being converted to equities even though the dividend payments have earlier been made. The third one which is irredeemable non-convertible preference shares cannot be converted to equities. The shareholder can only sell his shares in the secondary market as the contract is usually rolled over at its maturity.

Derivatives

Derivatives are instruments that come from other securities otherwise referred to as underlying assets, that is, the derivative is derived from them. The price, riskiness, and function of the derivative are dependent upon the underlying assets because anything that affects the underlying asset must affect the derivative. This may be an asset, index, or even situation and are most common in developed countries.

Debentures

Debentures are debt instruments that are not backed up by any collateral and they usually have a term that is greater than ten years. In other words, debentures are generally unsecured. They are backed up only by creditworthiness as well as the reputation of the issuer. Corporations and the government usually issue debentures in order to raise capital or funds for specific purposes. Here, they accumulate funds by borrowing money from the public.

Mutual funds

Mutual funds refer to funds that are created when a number of investors make contributions. The company then invests the money in securities such as equities, bonds, and money market instruments as well as other securities that are available in the market. Investors have the opportunity to invest in diversified and professionally managed securities at a cost that is relatively low. One can choose to manage these funds through experts and professional portfolio managers who will carry out careful research before investing money.

Exchange-traded funds (ETFs)

Exchange-traded funds are just like mutual funds, however, the difference between the two is that Exchange-traded funds are traded on the stock exchange and their expense ratio is comparatively low. In India, most investors prefer to invest in ETFs because they are registered with the Securities and Exchange Board of India (SEBI).

Capital market examples

Examples of capital markets include the American Stock Exchange, New York Stock Exchange, NASDAQ capital market, London Stock Exchange, BMO capital market, and ethernet capital market. Instead of trading securities on an organized exchange, they can be traded over the counter.

The benefits of capital market investment

  1. Savings
  2. Income
  3. Wealth or capital gain
  4. Securities as collateral
  5. Liquidity
  6. Tax advantages
  7. Confidentiality
  8. Flexibility
  9. Operating convenience
  10. Hedge against inflation
  11. Risk spreading and maximization of returns

Savings

When one invests in securities that are listed in the capital market, he is encouraged to accumulate savings in small amounts over a period of time.

Income

Investing in this market makes provision for a source of income. This implies that shares pay dividends to the shareholder when companies declare profits and decide to distribute part of the profits. Bonds pay interest income to bondholders. there are times that the income earned from listed securities exceeds the interest earned from the money or banking sector.

Wealth or capital gain

As the prices of securities listed in the market rise, there will also be a corresponding increase in the value of the investment of the holders of those securities. This refers to capital gains and it is a critical way of growing wealth through the stock market. One ought to note that a one-off investment in the capital market makes no sense. The investment should be accumulative over time which creates opportunities for wealth growth through the capital market.

Securities as collateral

Securities that are listed are easily acceptable as collateral against loans from financial institutions. These securities are a representation of stocks of wealth.

Liquidity

In this context, liquidity refers to the ability to convert shares or bonds into cash by making sales within the shortest time possible without having to lose much value. When one is in need of funds urgently, listed securities could be very useful. This is so because they are said to be more liquid than other forms of assets such as real estate. In other words, they can be transferred at a low cost of a transaction. It becomes possible for an investor to buy and sell at considerable convenience.

Tax advantages

Withholding tax on dividends is 5% and dividends is 15% for locals. This is very low when we compare it to alternative investments which attract higher taxes.

Confidentiality

When one invests in securities, he is guaranteed confidentiality in the management of wealth because financial securities are intangible in nature.

Flexibility

The trade of shares takes place in units and lots that investors of different levels of income can afford. Bonds also are fairly affordable when compared to alternative investments such as real estate. Because of this, investment in securities can be customized to investors, specific incomes.

Operating convenience

As a result of the fact that investing in securities implies the separation of ownership from management, it does not require the investor to be personally committed in order for it to give a return. this then saves investors from occupational hazards of careers as it is opposed to other businesses that require the physical presence and involvement of the entrepreneur.

Hedge against inflation

The prices of securities over the long term tend to outperform inflation. With this, the investment in securities can be a reliable hedge against inflation in the long run.

Risk and maximization of returns

The range and variety of securities listed on the stock exchange provide an opportunity for investors to maximize their exposure to specific risks by spreading their investments across a wide selection of stocks. The use of collective investment schemes such as mutual funds and unit trusts has made this benefit more concrete, which invests pooled savings with the use of specialized expertise that is beyond an individual investor’s ability.

Capital market line and formula

The capital market line (CML) is the representation of portfolios that optimally combine risk and return. The slope of the capital market line is the theoretical concept that represents all the portfolios that optimally combine the risk-free rate of return and the risky assets’ market portfolio. Investors will make a choice on the capital market line under the capital asset pricing model, in equilibrium by borrowing or lending at a rate that is risk-free as this brings about maximization of return for a given risk level.

Capital market line formula

The formula is being expressed as;

ERp = Rf + SDp * (ERm – Rf) /SDm Where;

where,

ERp = Expected Return of Portfolio

Rf = Risk-Free Rate

SDp = Standard Deviation of Portfolio

ERm = Expected Return of the Market

SDm = Standard Deviation of Market

Capital market line vs security market line

The capital market line is different from the security market line. While the former represents the rate of return for a specific portfolio, the latter represents the market’s risk and return over a given period of time. It also represents the expected returns of individual assets. The security market is derived from the capital market line.

Money market vs capital market

The major difference between money market and capital market is that while the money market deals in the buying and selling of short-term securities, the capital market deals in the buying and selling of long-term securities. In other words, the securities of the capital market have longer securities than those of the money market.

What distinguishes the money market from the capital market?

While the money market is the market for trading short-term securities, the capital market is the market for trading long-term securities.

What is a capital market?

The capital market is the market for trading long-term securities such as bonds and equities. Stocks and bonds are capital market security examples. It is an exchange system platform where the transfer of capital from investors who desire to employ their excess capital to businesses that require capital to finance different projects or investments.

What is a capital market instrument?

A capital market instrument is the financial instruments traded in the capital market such as bonds, equities, and debentures.

What is capital market line?

The capital market line (CML) is the representation of portfolios that optimally combine risk and return.

How does a cost-efficient capital market help reduce the prices of goods and services?

It is generally necessary for the prices of goods and services to cover their costs such as labor, materials, and capital. The costs of capital to a borrower include a return to the saver who made the capital available which includes a mark-up called a spread for the financial intermediary (capital market) bringing the saver and the borrower together. The more efficient the financial system, the lower will be the costs of intermediation. In turn, the prices of goods and services will be to consumers.

In a simple perfect capital market what happens if dividends are delayed?

Share prices remain unchanged.

Last Updated on July 8, 2022 by Nansel Nanzip Bongdap
Joy Sunday Zaleng
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