Financial Markets

Types of Security?

There are four main types of security:

• debt securities
• equity securities
• derivative securities
• hybrid securities, which are a combination of debt and equity.
 Debt Securities

Debt securities, or fixed-income securities, represent money that is borrowed and must be repaid with terms
outlining the amount of the borrowed funds, interest rate, and maturity date.
In other words, debt securities are debt instruments, such as bonds (e.g., a government or municipal bond)
or a certificate of deposit (CD) that can be traded between parties.
Debt securities, such as bonds and certificates of deposit, as a rule, require the holder to make the regular
interest payments, as well as repayment of the principal amount alongside any other stipulated contractual
rights.
Such securities are usually issued for a fixed term, and, in the end, the issuer redeems them.
A debt security’s interest rate on a debt security is determined based on a borrower’s credit history, track
record, and solvency – the ability to repay the loan in the future. The higher the risk of the borrower’s
default on the loan, the higher the interest rate a lender would require to compensate for the amount of risk
taken.
 Equity Securities

Equity securities represent ownership interest held by shareholders in a company. In other words,
it is an investment in an organization’s equity stock to become a shareholder of the organization.
The difference between holders of equity securities and holders of debt securities is that the
former is not entitled to a regular payment, but they can profit from capital gains by selling the
stocks. Another difference is that equity securities provide ownership rights to the holder so that
he becomes one of the owners of the company, owning a stake proportionate to the number of
acquired shares.
In the event a business faces bankruptcy, the equity holders can only share the residual interest
that remains after all obligations have been paid out to debt security holders. Companies
regularly distribute dividends to shareholders sharing the earned profits coming from the core
business operations, whereas it is not the case for the debtholders.
 Derivative Securities

Derivative securities are financial instruments whose value depends on basic

variables. The variables can be assets, such as stocks, bonds, currencies,
interest rates, market indices, and goods. The main purpose of using
derivatives is to consider and minimize risk. It is achieved by insuring
against price movements, creating favorable conditions for speculations and
getting access to hard-to-reach assets or markets.
Formerly, derivatives were used to ensure balanced exchange rates for goods
traded internationally. International traders needed an accounting system to
lock their different national currencies at a specific exchange rate.
 There are four main types of derivative securities:

1. Futures
Futures, also called futures contracts, are an agreement between two parties for the purchase and delivery
of an asset at an agreed-upon price at a future date. Futures are traded on an exchange, with the contracts
already standardized. In a futures transaction, the parties involved must buy or sell the underlying asset.
2. Forwards
Forwards, or forward contracts, are similar to futures, but do not trade on an exchange, only retailing.
When creating a forward contract, the buyer and seller must determine the terms, size, and settlement
process for the derivative.
Another difference from futures is the risk for both sellers and buyers. The risks arise when one party
becomes bankrupt, and the other party may not able to protect its rights and, as a result, loses the value of
its position.
3. Options
Options, or options contracts, are similar to a futures contract, as it involves the purchase or
sale of an asset between two parties at a predetermined date in the future for a specific
price. The key difference between the two types of contracts is that, with an option, the
buyer is not required to complete the action of buying or selling.

4. Swaps
Swaps involve the exchange of one kind of cash flow with another. For example, an interest
rate swap enables a trader to switch to a variable interest rate loan from a fixed interest rate
loan, or vice versa.
 Hybrid Securities

Hybrid security, as the name suggests, is a type of security that combines characteristics of both debt and
equity securities. Many banks and organizations turn to hybrid securities to borrow money from
investors.
Similar to bonds, they typically promise to pay a higher interest at a fixed or floating rate until a certain
time in the future. Unlike a bond, the number and timing of interest payments are not guaranteed. They
can even be converted into shares, or an investment can be terminated at any time.
Examples of hybrid securities are preferred stocks that enable the holder to receive dividends prior to the
holders of common stock, convertible bonds that can be converted into a known amount of equity stocks
during the life of the bond or at maturity date, depending on the terms of the contract, etc.
Hybrid securities are complex products. Even experienced investors may struggle to understand and
evaluate the risks involved in trading them. Institutional investors sometimes fail at understanding the
terms of the deal they enter into while buying hybrid security.
Types of Financial Market
 CAPITAL MARKET

Capital Market is a place where money is exchanged between people

who have excess of it, to those who are in deficit.
EXAMPLE
XYZ Wants to expand business ACE Textiles PVT. Ltd. Mr. Ace
Makes a Business Deal with GUCCI brand to export textile cloth to
their manufacturing unit
Where can he get the money from?
 EXAMPLE

1. From Banks Mr. Ace can approach banks, but it will not prove to be a
healthy option because:
-Bank will charge him High rate of interest.
- Lending of loans is a very tedious task. Bank first scrutinizes the papers/
documents, verifies them.
- Very time Consuming Process.
- Thus, this idea is not an effective one.
2. Can Go Public and get listed on the stock companies.
 Meaning of Capital Market

Capital Market is the part of financial system which is concerned with

raising capital funds by dealing in Shares, Bonds, and other long-term
investments.
The market where Investment instruments like bonds, equities and
mortgages are traded is known as the capital market.
The different types of financial instruments that are traded in the
capital markets are:
1. equity instruments
2. debt instruments,
3. insurance instruments,
4. foreign exchange instruments,
5. hybrid instruments.
 Nature of capital market

The nature of capital market is brought out by the following facts:

It Has Two Segments
It Deals In Long-Term Securities
It Performs Trade-off Function
It Creates Dispersion In Business Ownership
It Helps In Capital Formation
It Helps In Creating Liquidity
 Types of capital market

There are two types of capital market:

Primary market,
Secondary market
 Primary Market

It is that market in which shares, debentures and other securities are sold for the
first time for collecting long-term capital.
This market is concerned with new issues. Therefore, the primary market is also
called NEW ISSUE MARKET.
In this market, the flow of funds is from savers to borrowers (industries), hence,
it helps directly in the capital formation of the country.
The money collected from this market is generally used by the companies to
modernize the plant, machinery and buildings, for extending business, and for
setting up new business unit.
 Features of Primary Market

It Is Related With New Issues

It Has No Particular Place
It Has Various Methods Of Float Capital:
Following are the methods of raising capital in the primary market: i)
Public Issue ii) Offer For Sale iii) Private Placement iv) Right Issue v)
Electronic-Initial Public Offer
It comes before Secondary Market
 Secondary Market

The secondary market is that market in which the buying and selling of the previously
issued securities is done.
The transactions of the secondary market are generally done through the medium of
stock exchange.
The chief purpose of the secondary market is to create liquidity in securities.
If an individual has bought some security and he now wants to sell it, he can do so
through the medium of stock exchange to sell or purchase through
The medium of stock exchange requires the services of the broker presently, there are
24 stock exchange in India.
 Features of Secondary Market

It Creates Liquidity
It Comes After Primary Market
It Has A Particular Place
It Encourages New Investments
Money Market