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Financial Instruments

It is a claim against a person or an institution for payment of a sum of money or periodic payment in the form of interest or  dividend at a specified future date. Financial Instruments can be classified in two types such as Capital Market Instruments and Money Market Instruments

A). CAPITAL MARKET INSTRUMENTS

Capital Market Instruments consist of long term instruments for the period of more than one year. It includes:

1). Equity Shares- Equity shares represent the owner’s capital in the company. The holders are the real owners of the company.

  • They have a control over the working of the company.
  • Equity shareholders are paid dividend.
  • They provide permanent capital to the company and cannot redeem during life time of the company.

2). Preference Shares – Preference Shares are shares of company’s stock with dividends that are paid out to shareholders  before common stock dividends are issued.  These shares have their certain preferences as compared to other types of share.  These  shares are given two preferences such as:

  • Whenever the company has distributable profits, the dividend is first paid on preference shares.
  • Repayment of the capital at the time of liquidation.

3). Debentures- A debenture is an acknowledgement of a debt. It is a document under company’s seal which provide for the payment of principal sum and interest thereon.

  • A debenture holder is a creditor of a company and interest is paid to him.
  • Debentures are to be repaid after a definite period of time.

4). Derivative – A derivative is a security with a price that is dependent upon or derived from one or more underlying assets. Derivative is itself a contract between two parties based upon the asset or assets.

  • The underlying assets include stocks, bonds, commodities, currencies.
  • It can be traded over the counter or an exchange.

Derivative can be classified as follow:

  • Futures Contract- Futures Contract is an agreement between two parties for the sale of assets at an agreed upon prices.
  • Forward Contract- Forward Contract is similar to futures contract but the only difference is this that it is not traded on exchange but only traded on over the counter.
  • Swaps- It is a contract between two parties agreeing to trade long terms.
  • Options- It is also similar to futures contract but the key difference is that with an option buyer and seller is not obliged to make transaction if he or she decides not to.

5). Bonds- A bond is a debt investment in which an investor loans money to an entity which borrows a fund for a defined period of time at a variable or fixed rate interest. It is similar to debentures but the key difference is that it is issued by a government institute.

B). MONEY MARKET INSTRUMENTS

Money Market Instruments consist of short term instruments for a period of up to one year. It includes:

1). Call Money - The Call Money Market deals in short term finance repayable on demand.

  • Funds are lent and borrowed without collateral.
  • Maturity period of call loans varies from one day to fortnight.

2). Treasury Bills - It is a short term debt instrument issued by government of India and is presently issued in three tenures i.e. 91 days, 182days and 364 days.

  • Treasury bills are zero coupon securities and pay no interest.
  • They are issued at discount and redeemed at face value at maturity.

3). Certificate of Deposit - Certificate Deposit are used by banks and issued to the depositors for a specified period less than one year- they are tradable and negotiable in the market.

4). Commercial Papers - It is used by corporate houses of India which should be a listed company. These companies need to obtain a specified credit rating from an agency approved by the RBI such as CRISIL

5). Commercial Bills

  • Commercial Bills are issued by the All India Financial Institutions (AIFI), Non Banking Finance Companies (NBFCs), Scheduled Commercial Banks, Merchant Banks,  Co-operative Banks and Mutual Funds.
  • Maturity of these bills is 30 days, 60 days and 90 days.

 

Sample Questions

Q1. Capital market instruments consist of long term instrument for the period of more than one year, which of the following is / are capital market instrument?

a). Equity Shares

b). Preference Shares

c). Debentures

d). All of above

Q2. What is paid on the equity shares to the equity shareholders?

a). Dividend

b). Interest

c). Both

d). None of these

Q3. Which of the following instruments provide permanent capital to the company and cannot redeem during the life time of the company?

a). Equity Shares

b). Preference Shares

c). Debentures

d). Bond

Q4. What is paid on the preference shares to the preference shareholders?

a). Interest

b). Dividend

c). Both

d). None of these

Q5. What is paid on debentures to the debenture holder?

a). Interest

b). Dividend

c). Both

d). None of these

Q6. Which of the following is the example of derivatives?

a). Futures

b). Forwards

c). Options

d). All of above

Q7. _____is an agreement between two parties for the sale of assets at an agreed upon prices

a). Futures Contract

b). Forwards Contract

c). Options

d). Swaps

Q8. ______is a contract between two parties agreeing to trade long terms

a). Futures

b). Forwards

c). Swaps

d). Options

Q9. Which of the following is not a short term instrument?

a). Call Money

b). Commercial Papers

c). Bonds

d). Certificate of Deposits

Q10. Which of the following is a zero coupon securities on which no interest is paid?

a). Call Money

b). Treasury Bills

c). Commercial Papers

d). None of these

Answers:

1). (d) all of above

2). (a) Dividend is paid on the equity shares to the equity shareholders

3). (a) Equity Shares provide permanent capital to company and cannot redeem during the life time of the company.

4). (b) Dividend is paid on the preference shares to the preference shareholders.

5). (a) Interest is paid on the debenture to the debenture shareholders

6). (d) all of above

7). (a) Futures Contract is an agreement between two parties for the sale of assets at an agreed upon prices

8). (c) Swap is a contract between two parties agreeing to trade long terms

9). (c) Bonds is not a short term instruments

10). (b) Treasury Bills is a zero coupon securities on which no interest is paid.

 

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