CAPITAL MARKET INSTRUMENTS & SECURITIES

CAPITAL MARKET INSTRUMENTS
Capital market instruments are fixed-income obligations that trade in the secondary market, which means anyone can buy and sell them to other individuals or institutions. Marketable securities are exchanged through the organized markets for example, stock exchanges and its Representative dealers and brokers who sell and buy marketable securities on behalf of their customer in exchange of commission.  

Therefore, the capital market instruments fall into four categories such as:  
Treasury securities; government agency securities; municipal bonds; and corporate bonds.

1. Treasury Instruments

All government securities issued by the Treasury department of Govt. are fixed income instruments. They may be bills, notes, or bonds depending on their times to maturity. Specifically, bills mature in one year or less, notes in over one to 10 years, and bonds in more than 10 years from date of issue government securities which confer debt obligations on the government.  

2. Government Bonds and Loan Stocks  
Government securities are sold by the apex banks on behalf of the government to support specific programs, but they are not direct obligations of the treasury department. Mortgage bonds are issued and sold for the purpose of using the proceeds to purchase mortgages from insurance companies or savings and loans; and the home loan which sells bonds and loans the money to its banks, which in turn provide credit to savings and loans and other mortgage-granting institutions. Other agencies are the government banks for cooperatives.

3. State and Local Government Bonds  
These bonds are issued by local government entities as either general obligation or revenue bonds. General obligation bonds are backed by the full taxing power of the municipality, whereas revenue bonds pay the interest from revenue generated by specific projects. These bonds differ from other fixed-income securities because they are tax-exempt. The interest earned from them is exempt from taxation by the government and by the state that issued the bond, provided the investor is a resident of that state. For this reason, these bonds are popular with investors in high tax brackets.

4. Corporate Bonds
Corporate bonds are fixed-income securities issued by industrial corporations, public utility corporations, or railroads to raise funds to invest in plant, equipment, or working capital. They can be broken down by issuer, in terms of credit quality in terms of maturity i.e. short term, intermediate term, or long term, or based on some component of the indenture.

CAPITAL MARKET SECURITIES
These are fixed-income obligations that trade in the secondary market, which means anyone can buy and sell them to other individuals or institutions. Marketable securities are exchanged through the organized markets for example, stock exchanges and its Representative dealers and brokers who sell and buy marketable securities on behalf of their customer in exchange of commission. Instruments issued and traded in the capital market differ in certain characteristics, such as: term to maturity; interest rate paid on the nominal value; interest payment dates; and nominal amount in issue.  

1. Interest Rate Securities

The interest paid on the nominal amount of capital market securities (called the coupon rate) appears on the certificate received by the holder (the investor) of such a security. This coupon rate is one of the parameters used to determine the consideration paid for the security when traded in the secondary market. Most securities are issued at a fixed coupon rate.  

Capital market securities are physical certificates and the issuer of the security keeps a register of owners. This register is used by the borrower (issuer) to pay interest to the lender (owner of the security) on the interest payment dates indicated on the certificate. When an instrument is sold to a new owner in the secondary market, the buyer is registered as the new owner on the settlement date of the transaction.  

2. Zero-rated coupons
These are long-dated securities with many terms to maturity with zero-rated coupons which are capital market instruments issued by borrowers of money such as blue chip firms. These instruments do not earn interest on the capital amount invested by the lender, and are therefore issued and traded at a discount on the nominal value, similar to discount instruments in the money market such as bankers acceptances and treasury bills.

The market value (nominal value less discount) of zero or nil-rated coupon bonds depends on the yield that the investor (lender) expects on his investment. The redemption amount, which is the only cash inflow for the investor, is equal to the nominal value of the bond, and is thus known to the investor.

3. Asset-backed Securities
Where an asset exists which represents cash inflow stream such as a normal loan or investment, a bond can be issued to fund this asset. The bond income is then derived or backed by the income stream of the asset. The performance on the bond is then dependent on the asset performance.

INSTITUTIONAL PARTICIPANTS IN CAPITAL MARKET
There are a number of financial institutions which are directly involved with real investment in the economy. These institutions mobilize the saving from the people and channel funds for financing the development expenditure of the industry and government of a country.  

The financial institutions take maximum care in investing funds in those projects where there is high degree of security and the income is certain. The main institutional sources of capital market are as follows:

(i) Insurance Companies.
Insurance companies are financial intermediaries. They call money by providing protection from certain risks to individuals and firms. The insurance companies invest the funds in long term investments primarily mortgage loans and corporate bonds.

(ii) Pension Funds.
The pension funds are provided by both employees and employers. These funds are now increasingly utilized in the provision of long term loans for the industry and government.

(iii) Building Societies.
The building societies are now activity engaged in providing funds for the construction, purchase of buildings for the industry and houses for the people.

(iv) Investment Trusts.
The investment trust mobilize saving and meet the growing, need of corporate sector, The income of the investment trust depends upon the dividend it receives from shares invested in various companies.  

(v) Unit Trust.
The Unit Trust collects the small savings of the people by selling units of the trust. The holders of units can resell the units at the prevailing market value to the trust itself.  

(vi) Saving Banks.
The saving banks collect the savings of the people. The accumulated saving is invested in mortgage loans, corporate bonds.

(vii) Specialized Finance Corporation.
The specialized finance corporations are being established to help and provide finance to the private industrial sector in the form of medium and long term loans or foreign currencies.

(viii) Commercial banks.
The commercial banks are also now activity engaged in the provision of medium and long terms loans to the industrialists, agriculturists, specialist finance institutions, etc., etc.

(ix) Stock Exchange.
The stock exchange is a market in existing securities (shares, debentures and securities issued by the public authorities). The stock exchange provides a place for those persons who wish to sell the shares and also wish to buy them. Stock Exchange, thus helps in raising equity capital for the industry

The capital market

Having discussed what financial system is, then there is the need to go further by touching the various components of the system. Therefore this post will be focusing on capital market which together with the money market makes up the important component of the financial system known as financial market.

Therefore, capital markets are financial markets for the buying and selling of long-term debt or equity-backed securities. These markets channel the wealth of savers to those who can put it to long term productive use, such as companies or governments making long-term investments In another perspective, capital market is a market in which financial securities such as stocks, bonds and government loan instrument are bought and sold. Corporate entities and governments therefore, use capital market to raise funds for their operations and programmes respectively. For example, a company may float an initial public offer while a government may issue bond or development loan stock to raise funds for new projects or ongoing public programmes Investors purchase securities (stocks or bonds) in the capital markets in order to extract some returns or earn profits on their investment. Capital markets include primary markets, for the initial public offers of securities that are placed with investors through issuing houses and underwriters, and secondary markets, in which all subsequent trading on existing securities takes place.  

Financial regulators, such as the UK's Bank of England (BoE) or the U.S. Securities and Exchange Commission (SEC), oversee the capital markets in their jurisdictions to protect investors against fraud, among other duties. The Nigerian Securities and Exchange Commission also perform the same function


Transactions in modern capital markets are almost invariably carried out based on computer-operated electronic trading systems; most can be accessed only by entities within the financial sector or the treasury departments of governments and corporations, but some can be accessed directly by the public.  

There are many thousands of such systems, most only serving only small parts of the overall capital markets. Entities hosting the systems include stock exchanges, investment banks, and government departments. Physically the systems are hosted all over the world, though they tend to be concentrated in financial hubs or centres such as Lagos, London, New York, and Hong Kong, among others  

There is an important division between the stock markets mainly for equity securities, in form of shares, which investors purchase for the purpose of having ownership interest in the companies that float such securities. The other is the bond markets which cater for creditors when they subscribe to the securities floated by companies for raising funds on the basis of debts that have maturity dates before they are repaid back to the holders.  

Operations of a Capital Market
In respect of the operations of the capital market, there are different players that are active in the secondary segment of the market. Such players include the following.

Regular individual investors
These participants in the market account for a small proportion of trading, though their share still plays some significant role in the market. A few wealthy individuals who could afford an account with a broker, but transactions are now much cheaper and accessible over the internet.  

Traders
These are the jobbers and stock brokers. The jobbers in highly developed capital markets operate by buying securities with the intention of making profits. The do not transact business on behalf of any investors but behave like real traders who engage in buying and selling of capital market securities.

The profit earned by the jobbers is called the jobbers turn. On the other hand, the stock brokers transact business on behalf of investors who pay commission on volume of transactions done for them by the stockbrokers. There are numerous small traders who can buy and sell securities on the secondary markets using platforms provided by brokers which are accessible through electronics means such as with web browsers. When such an individual trades on the capital markets, it will often involve a two stage transaction.  

First they place an order with their broker, on the strength of which the broker executes the trade. If the trade can be done on an exchange, the process will often be fully automated. If a dealer needs to manually intervene, this will often mean a larger fee.  

Investment banks
Traders in investment banks will often make deals on their bank's behalf, as well as executing trades for their clients. Investment banks will often have a department called capital markets. Staff in such department try to keep abreast of the various opportunities in both the primary and secondary markets, and will advise major clients accordingly.  

Pension and Sovereign Wealth Funds  
These players tend to have the largest holdings, though they tend to buy only the highest grade securities which are safest types of bonds and shares, and often don't trade all that frequently.  

Hedge funds  
These are increasingly making most of the short-term trades in large sections of the secondary markets of advanced economies such as the UK and US stock exchanges, which is making it harder for them to maintain their historically high returns, as they are increasingly finding themselves trading with each other rather than with less sophisticated investors.

Divisions in the Capital market .
The capital market is divided into two sectors depending on the type of issues they deal in and they are as follows,

Primary market
The capital market is operated in two main segments such as the primary market and the secondary market. The primary market is used for transactions on new stocks or bond issues, which are handled by issuing houses and underwriters.  

The main entities seeking to raise long-term funds on the primary capital markets are governments (which may be local, state or federal) and business enterprises (companies). Governments tend to issue only bonds, whereas companies often issue either equity or bonds.  

The main entities purchasing the bonds or stock include pension funds, hedge funds, sovereign wealth funds, and less commonly wealthy individuals and investment banks trading on their own behalf.  

Characteristics  of primary market
The characteristics of a primary market include the following.

i ) This is the market for new long term capital. The primary market is the market where the securities are sold for the first time.Therefore it is also called New Issue Market (NIM)

ii) In a primary issue, the securities are issued by the company directly to investors

iii) The company receives the money and issue new security certificates to the investors

iv) Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business

v) The primary market performs the crucial function of facilitating capital formation in the economy

vi) The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in the new issue market may be raising capital for converting private capital into public capital; this is known as ‘going public’


Methods of getting new issues into the market  
The major issuers of securities particularly the shares are the corporate entities. Government bonds are commonly referred to as "gilt-edged" securities. Intermediaries such as brokers and banks (especially merchant banks) are often used by borrowers to administer the issuing of new bonds. Bonds can be issued in the primary market using several different methods. Both equities and bonds can be issued through the following ways:   

a) Public Subscription  
This presupposes that a prospectus is issued. The document contains details of the company issuing the security such as bond or shares, and of the securities themselves. Members of the public can then subscribe to the security, and the borrower or an intermediary on behalf of the borrower will allocate the securities to subscribers on issue date by means of a certain process.

b) Private Placing
The securities (e.g., shares or bonds can also be issued through private placing. This method is used when the borrower (or an intermediary on behalf of the borrower) places bonds or shares with certain investors selected by the borrower. The selected investor would then receive a certain amount of bonds or shares at issue date and pay the borrower the issue price for the bonds received.

c) Tender Method
A third method used to issue bonds or shares is known as the "tender" method. The borrower or intermediary will issue a media statement that bonds shares will be issued in the market on a certain date.  

The details of the bonds shares and the capitalisation of the issue (total nominal amount to be issued) will also be communicated. Interested parties are then invited to tender before a certain date for these bonds. Tenders from interested parties would normally consist of the nominal amount plus the percentage of the nominal amount that the interested party is willing to pay for the shares or bonds at issue. The company or borrower usually allots the shares or bonds in order of highest tenders first, but it is in his power to decide who will receive the securities at issue date.

d) Tap Method
Another method that is used to issue new instruments is known as the "tap" method, whereby not all the shares or bonds are allocated at the first issue through any of the above three methods. If, for instance, the company or borrower wants to issue N100 million worth of shares or bonds he can choose to issue only N70 million at the first issue. The borrower or intermediary then starts creating a secondary market for these instruments by buying and selling the issued instruments in the secondary market. This process, where one party buys and sells the same instrument in the market, is known as market making.  

The market maker thus has a bid (to buy) and an offer (to sell) in the market for the same instrument, trying to create an active and liquid market in this instrument. The "tap" method is then used by the borrower or intermediary, whereby more instruments are sold in the market than that bought back. By using this method, the amount of the issue is increased, often without the market realising it.  

This method can also be used in inverse form to decrease the total outstanding loan. The ultimate user of the funds from the securities in the capital market can use the tap method, because the company is allowed to trade in its own securities. This is possible in the equities market because a company is allowed to buy its own shares.

Secondary Market

In the secondary markets, existing securities are sold and bought among investors or traders, usually on a stock exchange, characterized by over-the counter, or operated electronically in highly developed economies.  

The existence of secondary markets increases the willingness of investors in primary markets, as they know they are likely to be able to swiftly cash out their investments if the need arises. Transactions in secondary markets: Most capital market transactions are executed electronically, but in less developed stock exchanges sometimes traders are directly involved and sometimes unattended computer systems in highly developed stock exchanges execute the transactions, such as in algorithmic trading system. Most capital market transactions take place on the secondary market. On the primary market, each security can be sold only once, and the process to create batches of new shares or bonds is often lengthy due to regulatory requirements.  

On the secondary markets, there is no limit on the number of times a security can be traded, and the process is usually very quick. With the rise of strategies such as highly frequency trading, a single security could in theory be traded thousands of times within a single hour.  

Transactions on the secondary market don't directly help raise finance, but they do make it easier for companies and governments to raise finance on the primary market, as investors know if they want to get their money back in a hurry, they will usually be easily able to resell their securities.  

Sometimes secondary capital market transactions can have a negative effect on the primary borrowers - for example, if a large proportion of investors try to sell their bonds, this can push up the yields for future issues from the same entity. In modern time, several governments have tried to avoid as much as possible the penchant for borrowing into long dated bonds, so they are less vulnerable to pressure from the markets.  

A variety of different players are active in the secondary markets. Regular individuals account for a small proportion of trading, though their share has slightly increased; in the 20th century it was mostly only a few wealthy individuals who could afford an account with a broker, but accounts are now much cheaper and accessible over the internet.  

These days there are now numerous small traders who can buy and sell on the secondary markets using platforms provided by brokers which are accessible with web  browsers. When such an individual trades on the capital markets, it will often involve a two stage transaction. First they place an order with their broker, then the broker executes the trade. If the trade can be done on an exchange, the process will often be fully automated. If a dealer needs to manually intervene, this will often mean a larger fee.  

Traders in investment banks will often make deals on their bank's behalf, as well as executing trades for their clients. Investment banks will often have a department called capital markets: staff in this department try to keep aware of the various opportunities in both the primary and secondary markets, and will advise major clients accordingly. Pension and Sovereign wealth funds tend to have the largest holdings, though they tend to buy only the highest grade (safest) types of bonds and shares, and often don't trade all that frequently

Nigeria Bourse Seeks to Start Trading Local Currency Futures

Nigeria Bourse Seeks to Start Trading
Nigeria Bourse Seeks to Start Trading Local Currency Futures

The Financial system

                       

The domestic financial system of any country refers to a set of instructional and other arrangements that transfer savings from those who generate them to those who ultimately use them for investment or consumption. It is made up of a mechanism for organizing and managing the payments for current and capital transactions; a mechanism for the collection and transfer of savings by banks and  other depository institutions; arrangements covering the activities of capital markets with respect to the issue and trading of marketable and transferable  long-term securities; arrangements covering the workings of money and credit markets dealing with short-term financial instruments; and arrangements covering the activities of financial market complementary to the capital market, credit and money markets, which in essence  provide hedging (or risk insurance) facilities, such as the new futures markets.

The financial system is complex, comprising many different types of private-sector financial institutions, including banks, insurance companies, mutual funds, finance companies, and investment banks- all of which are heavily regulated by the government. The Nigerian banking industry which is regulated by the Central Bank of Nigeria, is made up of; deposit money banks referred to as commercial banks, development finance institutions and other financial institutions which include; micro-finance banks, finance companies, bureau de changes, discount houses and primary mortgage institutions.

At international level, world financial system consists of a set of institutional and other arrangements governing the transfer of savings from those generating them to those wishing to use them, across national frontiers.

 Attributes of an Ideal Financial System

An ideal financial system is characterized by the following closely inter-connected attributes: it should be stable, efficient, competitive, flexible and balanced.

a. Stability  

It is imperative for confidence to be maintained in the financial system, especially in times of financial panic. It must be able to absorb shocks arising from the greater-than-anticipated and allowed for risks, and hence to contain a contractionary impact on activity, and trade, as well as any inflationary effect on prices.

 b. Efficiency
An efficient financial system directs savings to investments with the highest rate of return, allowing for risk. This consists of allocative, operating, and dynamic efficiency.

c. Competitiveness
A good financial system must have an adequate number of participants.

d. Flexibility  
The instruments employed and the methods of operation must be able to adapt to changes in the economic and financial structure.

e. Balanced
A balanced financial system requires that there should be an optimal mix of various types of financial system with respect to both transfer of current savings and the stock of past savings. The optimal mix would be such that changes in any one component could be absorbed by changes in another without having excessive impact on the providers and users of saving, while allowing both and adequate period of adjustment. It is important to note that the ideal combination of these closely inter-connected attributes will change as the process of economic growth proceeds.  

 The Nature of Financial Institutions 

A financial institution is an establishment that conducts financial transactions such as investments, loans and deposits. Almost everyone deals with financial institutions on a regular basis. Everything from depositing money to taking out loans and exchanging currencies must be done through financial institutions. According to Mishkin and Eakins (2012:46), “Financial institutions are what make financial markets work. Without them, financial markets would not be able to move funds from people who save to people who have productive investment opportunities. They thus play a crucial role in improving the efficiency of the economy.”

In financial economics, a financial institution is an institution that provides financial services for its clients or members. Probably the most important financial service provided by financial institutions is acting as financial intermediaries.
They are responsible for transferring funds from investors to companies in need of those funds. Financial institutions facilitate the flow of money through the economy. Most financial institutions are regulated by the government.

 Types of Financial Institutions

There are three major types of financial institutions (Siklos, 2001, Robert, E. W. and Quadrini, V. (2012)

1. Depositary Institutions : Deposit-taking institutions that accept and manage deposits and make loans, including banks, building societies, credit unions, trust companies, and mortgage loan companies

2. Contractual Institutions : Insurance companies and pension funds; and

3. Investment Institutions : Banks, underwriters, brokerage firms.


However, financial institutions can be broadly classified into two: banks or bank financial institutions, and non- bank financial institutions. Commercial bank, Central bank, Merchant bank and Development bank are institutions in the banking sector while building societies, hire purchase companies, insurance companies, pension funds, and investment trusts are non-bank financial institutions. Whilst liabilities of banks form part of the money supply, the liabilities of non-bank financial institutions do not; for they are referred to as near money.
In Nigeria, the following types of financial institutions can be classified:

a. Traditional financial institutions
b. Commercial Banks
c. Central Bank
d. Development Banks
e. Merchant Banks
f. Insurance Companies

Meaning of Financial Markets

Financial markets (money and capital markets) consist of institutions, agents, brokers and intermediaries (banks, insurance companies, pension funds) transacting purchases and sales of securities. Financial markets facilitate the movement of funds from those who save to those who invest in capital markets. The persons and institutions operate in the friendships, contracts and communications networks which form an external visible financial structure. Financial markets are divided into two: investors and financial institutions. These financial institutions are organizations which act as intermediaries, agents and brokers in financial transactions. Financial intermediates purchase securities for their own account and sell their own liabilities and ordinary shares etc, agents’ and brokers’ contract on behalf of others.

  Financial markets are made up of:

 i. Financial intermediaries

ii. Agents and brokers

iii. Investors and borrowers.

Financial intermediaries, agents and brokers make up financial institutions. Thus one can say that financial markets are made up of financial institutions, investors and borrowers.

Lines of defence in the financial system to avert crisis 

Banks, insurance companies and
other financial institutions form the
first line of defence against financial
crises. It is their responsibility to
remain viable and solvent, checking
the creditworthiness of borrowers and
thereby managing the risks that they
take on.

Measures adopted by public
authorities in order to prevent or
mitigate financial crises constitute a
second line of defence. These
measures include:

1. prudential regulation (i.e. rules
that financial institutions have
to comply with in order to
ensure effective risk
management and the safety of
depositors’ funds),
accompanied by the disclosure
of information so as to promote
market discipline;

2. prudential supervision (i.e.
ensuring that financial
institutions follow these rules);

3. monitoring and assessment
activities, which identify
vulnerabilities and risks in the
financial system as a whole.

If, despite all of these measures,
financial institutions run into trouble,
public authorities may need to
intervene.

The Bulls, And The Bears Of The Stock Market.

There are two basic market descriptions used to determine  the general direction of the market most times.The terms are used to describe general actions and attitudes, or sentiment, either of an individual ( bear and bull) or the market.


Bull Markets
The first one is known as the Bulls
market which is used to refer to the market when it is generally rising, typically signaling a strong economic state of the market where gains are the order of the day. A bull market is typified by generally rising stock prices, high economic growth, and strong investor confidence in the economy. A bull market is therefore a financial market where prices of instruments (e.g., stocks) are, on average, trending higher. A bull market is when everything in the economy is great, people are finding jobs, gross domestic product (GDP) is growing, and stocks are rising. Things are just plain rosy ! Picking stocks during a bull market is easier because everything is going up.

Bull markets cannot last forever though, and sometimes they can lead to dangerous situations if stocks become overvalued. If a person is optimistic and believes that stocks will go up, he or she is called a "bull" and is said to have a "bullish outlook". A news item is considered bullish if it is expected to result in higher prices. Bull markets are generally characterized by high trading volume.

Bear market
Bear market is the exact opposite of the bull market . A bear market is when the economy is bad, recession is looming, stock prices are falling and low investors confidence in the economy. Bear markets make it tough for investors to pick profitable stocks.
What this means is that there is
economic downturn, coupled with
rising unemployment figures and of course inflation. A bear market tends to be accompanied by widespread pessimism.

One solution to investment during a bearish market is to invest in small proportions in historically dividend paying companies. Where possible invest in big corporations that have records of gliding through hard economic times successfully. Don’t invest too much on a single stock. You can also diversify your investments into stocks that can never be out of demand. In order words, invest in companies that have long history of survival.

When the stock market slides downwards for a longer time , if market becomes bearish, the money you invest buys more shares and the stocks you possess have less value. Bearish situation gives you opportunity to build up more equity than when the market is soaring.
Another strategy is to wait on the sidelines until you feel that the bear market is nearing its end, only starting to buy in anticipation of a hull market. If a person is pessimistic, believing that stocks are going to drop, he or she is called a "bear" and said to have a "bearish outlook".