Introduction:
Capital market instruments are financial assets used to raise long-term funds within financial markets. They play a pivotal role in promoting business growth, which, in turn, fuels economic development. These financial instruments are traded in primary or secondary capital.
Let’s understand in detail the meaning, returns, and risks associated with different capital instruments.
What Are Capital Market Instruments?
There is a wide range of capital market instruments that can be used for long-term investment purposes. These include stocks that involve ownership in companies and debt instruments like bonds that offer regular interest payments. Other important tools are derivatives, Exchange-Traded Funds (ETFs), and foreign exchange instruments, among several others.
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Apart from having a unique risk-return profile, each of these instruments is suitable for different investment strategies and financial objectives.
Types of capital market instruments
Let’s dive deeper into some different types of capital instruments so you can decide which one suits you the best:
1. Stocks: Investing in stocks represents part ownership of the company. Stocks are issued by publicly traded companies, and you can invest in them to earn capital gains and regular dividends. Stocks carry high risk but also offer the potential to earn high returns.
2. Bonds: If you are looking for low-risk options, you can invest in bonds. These involve lending money to the bond issuer, which can be a company, the government, or the municipality. The bond issuer pays regular interest along with the principal amount after a specific period, which helps you earn a profit on your investment. The returns might be a bit lower than the stocks, but bonds also carry relatively lower risk.
3. Derivatives: These financial contracts are used for hedging risks or speculation. The price of derivatives is derived from fluctuations in one or more underlying assets, like shares, bonds, commodities, interest rates, etc. Under this, you get into a contract with the borrower to buy one or more of its underlying assets on a pre-specified date for a pre-specified price. This eases the impact of price fluctuations and uncertainties in the future. Derivative tools include forward contracts, futures contracts, options, swaps, and currency derivatives.
4. Mutual funds: A mutual fund gathers capital from multiple investors and invests it into stocks, bonds, and other securities. These funds are managed by professionals and allow you to invest in a lump sum as well as in instalments through a Systematic Investment Plan (SIP). They also offer diversification.
5. Exchange-Traded Funds (ETFs): ETFs give you a perfect combination of mutual funds and stocks. They are similar to mutual funds but are directly traded on the stock exchange. ETFs pool money from multiple investors and invest it in several capital market instruments.
6. Foreign exchange instruments: If you have an aptitude for currency movements, you can pursue this investment option. You can trade foreign exchange instruments in the market based on the movement of various currencies.
Things to keep in mind while investing in capital market instruments
You must keep the following things in mind while investing in capital market instruments:
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Before investing in any instrument, you must evaluate how much risk you are willing to take.
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Make investments in line with your financial requirements and objectives. Prepare your expectation chart for growth and returns.
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Keep in mind the costs associated with your investments, as these can eat into your returns. Investment instruments may involve management and transaction fees, among other costs. Be aware of these costs to avoid surprises later.
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To alleviate the risk, diversify your investment portfolio.
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When investing in the capital market, ensure that you remain up-to-date with economic factors, interest rate fluctuations and market trends.
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Do not forget to comply with the market rules and regulations.
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Perform detailed research to ensure that the issuer of the instrument is genuine.
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Weigh potential returns against the tax liabilities that will follow when you sell your investments.
To sum it up
Capital market instruments can offer a wide range of long-term investment opportunities. However, it is important to have complete knowledge of the risk-return ratio associated with each of them. Moreover, you must invest, keeping in mind your risk tolerance, financial goals, and market conditions.
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