Major Financial Instruments Used In Stock Exchange By: Mohammad Abeel Tareen Definition • Financial Instrument: is a contract that represent financial assets of one party (Lenders), and financial liability instruments of other party (Borrowers). Major Types • Stocks • Bonds Stock: is a share of ownership of a company. Bond: is a debt instruments issued by corporate, governments and other entities in order to finance projects or activities Risk On Bonds • The most well-known risk in • Market interest rates are a the bond market is interest rate function of several factors such risk - the risk that bond prices as the demand for, and supply will fall as interest rates rise. of, money in the economy, the By buying a bond, the inflation rate, the stage that the bondholder has committed to business cycle is in as well as receiving a fixed rate of return the government's monetary for a fixed period. Should the and fiscal policies. However, market interest rate rise from interest rate risk is not the only the date of the bond's risk of investing in purchase, the bond's price will bonds; fixed-income fall accordingly. The bond will investments pose four then be trading at a discount to additional types of risk for reflect the lower return that an investors: investor will make on the bond. Risk On Bonds • Call Risk • Reinvestment Risk The risk that a bond will be The risk that the proceeds from called by its issuer. Callable a bond will be reinvested at a bonds have call provisions, lower rate than the bond which allow the bond issuer to originally provided. For purchase the bond back from example, imagine that an the bondholders and retire the investor bought a $1,000 bond issue. This is usually done that had an annual coupon of when interest rates have fallen 12%. Each year the investor substantially since the issue receives $120 (12%*$1,000), date. Call provisions allow the which can be reinvested back issuer to retire the old, high- into another bond. But imagine rate bonds and sell low-rate that over time the market rate bonds in a bid to lower debt falls to 1%. Suddenly, that costs. $120 received from the bond can only be reinvested at 1%, instead of the 12% rate of the original bond. Types of Risk on Bonds • • Default Risk Reinvestment Risk The risk that the bond's issuer will be unable to pay the contractual interest or principal on the bond in • The risk that the proceeds from a timely manner, or at all. Credit a bond will be reinvested at a ratings services such as Moody's, lower rate than the bond Standard & Poor's and Fitch give originally provided. For credit ratings to bond issues, which example, imagine that an helps to give investors an idea of investor bought a $1,000 bond how likely it is that a payment that had an annual coupon of default will occur. For example, most federal governments have 12%. Each year the investor very high credit ratings (AAA); they receives $120 (12%*$1,000), can raise taxes or print money to which can be reinvested back pay debts, making default unlikely. into another bond. But imagine However, that over time the market rate small, emerging companies have so falls to 1%. Suddenly, that $120 me of the worst credit (BB and received from the bond can lower). They are much more likely only be reinvested at 1%, to default on their bond payments, in which case bondholders will instead of the 12% rate of the likely lose all or most of their original bond. investment. Company Or Corporation • A company can be defined as an "artificial person", invisible, intangible, created by Law, with a discrete legal entity, perpetual succession and a common seal. It is not affected by the death, insanity or insolvency of an individual member. Types Of Companies 1. A company limited by guarantee. Commonly used where companies are formed for non-commercial purposes, such as clubs or charities. The members guarantee the payment of certain (usually nominal) amounts if the company goes into insolvent liquidation, but otherwise they have no economic rights in relation to the company. Types Of Companies 2. A company limited by shares. The most common form of company used for business ventures. Specifically, a limited company is a "company in which the liability of each shareholder is limited to the amount individually invested" with corporations being. Types Of Companies 3.Unlimited Companies A type of investment in which a partner or investor can lose an unlimited amount of money. Members of the company with unlimited liability has unlimited liability for which they are liable even from their personal property if required.