Equity instruments are all kinds of contracts that contain information about the rights to the assets of an entity that remained after securing all creditors. In addition, these are the entity's obligations to deliver or issue its own equity instruments, particularly shares, warrants or stock options. In summary, these are all monetary liabilities of one entity relative to another. Commitments may occur in forms of a security or an accounting entry. A capital instrument is a form of monetary liability with a maturity of more than one year (E.F. Brigham, J. F. Houston 2012, p. 51).
Distribution of equity instruments
Equity instruments due to maturity can be divided into (E.F. Brigham, J. F. Houston 2012, p. 218):
- medium-term - maturity, from 1 year to 3 years,
- long-term - maturity, over 3 years,
- bank loans and borrowings, over 1 year,
- transferable securities.
The medium and long-term nature of these instruments means that they are used to raise funds intended primarily for financing investments, but rarely for current needs. The capital market consists of the securities market and the long-term loan market.
Capital market functions
The basic functions of the capital market include raising capital for a long period through the sale of securities. This type of capital is mainly used by entities investing in tangible and intangible assets related to business operations. Entities selling securities are called issuers. Buyers of securities, so-called investors, by lending capital to issuers, are able to raise income from the purchase, holding or sale of securities (M. Levinson 2014, p. 8).
A well-functioning capital market affects the proper functioning of the economy, because it favors the existence of phenomena favorable for its development, i.e.(M. Levinson 2014, p. 9):
- Mobilization and capital transformation, which involves the activation of free financial resources owned by many entities and their transformation into development capital for economic sectors.
- The valuation of securities, which means the assessment of their issuer, and indirectly the method of using the capital they have acquired. This affects the continuous control of the efficiency of the division of capital and the constant shaping of the direction of its flow to those sectors of the economy that are currently the most profitable.
- Effective capital allocation, and thus all capital flows to sectors of the economy, in which it will be used in the most effective way. This will contribute to the development of the entire economy.
- Raising income by investors through their share in trading in securities.
Examples of capital instruments
Having a security is necessary to exercise the rights described in the content of this document. However, the document itself does not decide on the nature of the security. The content presented in this document has an impact on the nature of the security. A security may constitute an independent subject of trade (J.C. Francis 2000, p. 43).
Among the most known securities, there are (E. Farhi, J. Tirole 2008, pp. 4-5):
- Bonds and mortgage bonds- these instruments constitute a debt security paper, which means that they express an obligation of the issuer to their holders to perform a specific monetary or non-monetary payment.
- Depository receipts and shares- these instruments are securities of a shareholder or shareholder nature, which means that their holder has the right to joint ownership of their issuer or its assets.
- Rights to shares and pre-emptive rights- these instruments are a derivative, because their existence and value depends directly on the value of the shares they acquire.
- Certificates and investment credits, participation units and other participation titles - these instruments are associated with institutions that deal with collective investment, while from a legal point of view participating entities do not constitute a security, but are classified as capital market instruments.
- Brigham E.F., Houston J.F.(2012), Fundamentals of financial, South-Western Cencage Learning.
- Farhi, E., Tirole J. (2008), Competing liquidities: corporate securities, real bonds and bubbles, National Bureau of Economic Research.
- Francis J.C. (2000), Investments, analysis and management, McGraw-Hill.
- Levinson M. (2014), Guide to Financial Markets The Economist in Associattion with Profile Books.
- Weiss D.M. (2009), Financial Instruments: Equities, Debt, Derivatives, and Alternative Investments, Penguin Group, United States.
Author: Karolina Kurcz