What are Financial Instruments and different types in India

Financial Instruments are nothing but legal agreement made between two or more in terms of cash, evidence of an entity, or an contract right to deliver, receive (cash/cheque/demand draft/bonds/bill of exchange/futures or option contract) is called an Financial Instrument. There are two main types of Financial Instruments available  in India.They are Government Securities and Industrial Securities.

Government Securities(G-Sec) :

They are nothing but fixed income securities which cannot be fake and most widely trusted as under Government RBI control. Government Securities are issued by different categories of Government like State Government and Central Government, Local Municipalities/Corporations, Electricity Board and various sector wise investments to attract people to develop the core bussiness. As this Securities are issued by Government the risk is very minimum and the interest rate also very minimum compares to many other private financial investment. The maturity period of the securities are different from five years to twenty years. The Central and State Governments generate money to increase Infrastructure, to generate new job opportunities and many other available to the resources in the state. The interest paid by these securities are fixed and paid every 3-6months of an minimum. The biggest investor of these securities are commercial banks to safe their investment and corporate to see their fixed returns even though the interest rate is less, to maintain a certain percentage of Statutory Liquidity Ratio (SLR) as well as an investment. These securities are sold in the primary market mainly through the auction mechanism. The RBI notifies issue of a new   tranche of securities. Prospective buyers submit their bids. The RBI decides to accept bids based on a cut off price. Government Securities are mainly bought by Institutional Investors. Insurance companies, provident funds, and mutual funds are the other large investors.

Industrial Securities:

These are securities issued by the corporate sector  to finance their long term and working capital requirements.  The Major Instruments that  fall under Industrial Securities are Equity shares, Preference Shares and Debuntures.

Equity Shares:

Equity Shares nothing but “high return risk” instrument. Equity shares don’t have any fixed return rate and thereby, no period of maturity.The company may or may not declare dividend on equity shares. Equity shares of major companies are traded on the stock exchanges. The major component of return to equity holders usually consists   of   market appreciation.

Preference Shares:

Preference Shares carry a fixed rate of dividends. These carry a preferential right to dividends over the equity shareholders. This means that equity share holders cannot be paid any dividends unless the preference dividend has been paid in full. Similarly on the winding up of the company, the preference share holders get back their capital before the equity share holders. In case of cumulative preference shares, any dividend unpaid in past years accumulates and is paid later when the company has sufficient profits. Now all preference shares in India are `redeemable’, i.e. they have a fixed maturity period. Thus, preference shares are sometimes called a `hybrid variety’ – incorporating features of debt as well as equity.

Call Money Market:

The loans made in this market are of a short term in nature ,overnight to a fortnight . This is commonly  inter-bank market.  Those banks  which are facing a short in terms of  cash deficit, borrow funds from the cash who have surplus funds in other banks.  The rate of interest is market driven and depends on the liquidity position in the banking system.

Commercial Paper (CP)  and Certificate of Deposits (CD) :

CPs are issued by  the corporates  to finance their working capital needs.  These are issued for short term maturities. These are issued at a discount and redeemed at face value. These are unsecured and therefore only those companies who have a good credit standing are able to access funds through this instrument. The rate of interest is that the market driven and depends on  the current liquidity position and the credit worthiness of the issuing company.

The characteristics of CDs and CPs are similar except that CDs are issued by the commercial banks.

Leave a Reply

Your email address will not be published. Required fields are marked *