Capital Market-Meaning, Instruments & Importance

Capital Market Instrument

The 3rd and main component of the financial system are the capital market instruments. The financial system also promotes financial production and innovation. Indian capital market tremendous growth in financial or capital formation.

In the form of differentiated financial assets in instruments. The maturity period of the financial system depends on the variety of securities.

The different type of securities or instruments used in capital market are discussed below:


A debenture is a type of loan acknowledgement which is taken by a company from the public. The debenture holders are entitled to get the interest at a specified rate on the face value or debenture. A company can issue the debentures with secured & it can be registered or unregistered.


The capital of the company can be divided in several parts with a definite value. Each part is known as share. The person who holds the share of the company or industries is known as Shareholder.

There are 2 types of shares companies may issue.

They are:

  • Equity Share
  • Preference Share

What is Equity Share?

The total capital of a company is divided into small and equal parts, each part is known as Equity share. Equity or ordinary shareholders are the real owners of the company. The shareholder can participate in the management of the company.

These shareholders have residual claims on the income asset of the company. The rate of dividend is determined by directors on the basis of the annual profit.

What is Preference Share?

Preference shares are those shares on which shareholders enjoy two preferential rights over the equity shareholders. These rights are:

  • Payment of dividend out of profit.
  • Repayment of capital in case of liquidation.

These shareholders do not have any right to participate in the management of the company. All preference shares are redeemable within 10 years.

Preference shares may be classified into different types, they are: Cumulative or non-cumulative, convertible or nonconvertible, participating or non-participating preference share.

3.Innovation in financial instrument

Innovation instruments are the new instruments which are issued by the companies and financial institutions in recent years for the purpose of study, which may be divided into 2 parts.

A.Issued by Companies

A variety or different types of instruments issued by companies for innovation in financial instruments.

i. Participating Debenture

Participating Debentures are those which are eligible to participate in the excess profit of the company after the payment of equity dividend.

ii.Third party convertible debentures

These are the debts with a warrant which entitle the holder to subscribe the equity of another firm of a preferential price intended at market price.

iii.Convertible debenture with options

The debentures have the options to exist either by companies debenture holders the term of the issue.

iv.Equity Share

These are a type of convertible debentures; these are the offer of exchange debentures for equity. This type of instrument is quite risky. coupon convertible notes

It is converted into shares but on the date of conversion they have to satisfy unpaid interest.

vi.Zero interest fully convertible debentures

This type of debentures generally contain no interest. It automatically and compulsory converted into shares after the specified time of period.

vii.Non convertible debenture with interests

These debentures have no option to buy a specified number of equity shares at a fixed rate on the expiry of a certain period of time.

viii.Fully convertible Debenture with interests

This debenture does not have any interest in a short period and after this period the option to apply to equity issued at premium without paying for the period.

B. Issued by Financial Companies

A variety or different types of instruments issued by financial companies for innovation in financial instruments.

i. Zero Coupon Bonds

Also interest is payable; these bonds are sold to customers at a discount rate. They have a long maturity period generally of 25 years.

ii. Elasting rate bonds

The interest rate of these bonds link to other rates such as bank rate, yield on treasury, maximum interest on term deposit, prime ending treasury Bill etc.

iii. Regular income Bonds

These are issued for a specified period of time. Their interest is payable half yearly on these bonds. The interest is paid at a predetermined rate. The bonds also carry options for investors and are called options for incentive.

iv. Retirement bonds

These bonds are issued for the person to get the installment of fixed amount after their retirement. Investors get the monthly fixed amount after the expiration of the waiting period which at the option of investors for example IDBI is such a type of bond in 1996 with a maturity of 10 years.

v.Capital gain bonds

These bonds are issued with two option maturity period of 3 year and 7 year. And 20% of discount form income tax is allowed on the investment is these bonds IDBI,ICICI and issuing these type of bond.These bond beneficial for individual who are tax payers.

vi. Growth Bonds

These bonds generally have the redemption period of 10 years. Some of the companies provide or put options at the end of 5 to 7 years.

vii. Index bonds

These bonds provide both the security of money invested and the potential of appreciation in the return to the investor and index Bonds have 2 parts, Deep discount bonds & Dispatchable index bonds.

Importance of Capital Market

1.The capital market plays an important role in mobilizing savings and the channel is in them into productive investment for the development of commerce & industries.

2.The capital market encourages the economic growth of the various institutions which operate in the capital market.

3.It encourages quantity & qualitative directions in the flow of funds and brings rational allocation of resources in an under-developed country.

4.The capital market provides incentives to the saver in the form of interest or dividend and transfer for investors. Thus it lends to capital formation.

5. Capital markets divate resources from unproductive sources to productive sources.

6.Capital market acts as an important link between saver and investors.The saver who does not spend all their income is called surplus unit and the borrow known as deficit unit.

7.The capital market is the transmission mechanism of surplus units and deficit units.

8.Capital market helps in capital formation and economic growth of the country.

9.Capital market raising long term funds and provision of a variety of services.

10.It creates proper channelisation of funds and mobilisation of financial resources.

11.Capital market promotes industrial development, growth and increased savings.

12.Capital market always promotes balanced economic growth of the country.

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