(a) What is a capital market? [5 marks] (b) Describe any three instruments used in the capital market. [15 marks]

Answer Details

(a) Capital market. A capital market is a market for the buying and selling of long-term financial securities, that is, funds and instruments that mature in more than one year. It brings together those who have surplus long-term funds (lenders and investors) and those who need long-term funds (governments and firms) for investment. Its institutions include the stock exchange, development banks, insurance companies, and issuing houses.

(b) Three instruments used in the capital market.

1. Shares (equities). A share is a unit of the ownership capital of a company. A shareholder is part-owner of the company and receives a share of profit called a dividend. Ordinary shares carry voting rights but variable dividends, while preference shares carry a fixed rate of dividend paid before ordinary shares but usually no voting rights.
2. Debentures (bonds/loan stock). A debenture is a written acknowledgement of a long-term loan to a company. The holder is a creditor, not an owner, and receives a fixed rate of interest whether or not the company makes a profit; the loan is repaid on maturity, and it may be secured on the company's assets.
3. Government stocks (development or government bonds). These are long-term securities issued by government to borrow from the public for development projects. They carry a fixed rate of interest and are repaid at a stated future date, and they are regarded as very safe investments.

(Other acceptable instruments include mortgages and treasury certificates of longer maturity.)