Instruments of the Capital Market

Investors and issuers in the capital market deal in a range of long-term instruments, each with a different risk-return profile and a different legal relationship between the issuer and the investor.

• Equity shares. Equity shares represent ownership capital in a company — a shareholder is a part-owner of the company, not merely a lender to it. Equity shareholders carry voting rights on company matters, and their return (dividend) is not fixed — it depends entirely on how much profit the company earns and how much of it the board decides to distribute. Equity shareholders are the company's residual claimants, meaning they are paid only after every other claim (creditors, debenture holders, preference shareholders) has been settled, both during normal operations and if the company is wound up. This makes equity shares the highest-risk, highest-potential-return instrument in the capital market.
• Preference shares. Preference shares carry a preferential right over equity shares in two specific respects: payment of dividend (usually at a fixed rate) and repayment of capital in the event of winding up. In exchange for this preference, preference shareholders ordinarily have no voting rights. Preference shares come in several varieties — cumulative (unpaid dividends accumulate and must be paid before any equity dividend) or non-cumulative, convertible (can later be converted into equity shares) or non-convertible, and redeemable (repaid after a fixed period) or irredeemable.
• Debentures and bonds. Debentures (and bonds) are debt instruments — when an investor buys a debenture, they become a creditor of the company, not an owner. The company promises to pay a fixed rate of interest, regardless of whether it earns a profit that year, and to repay the principal amount at maturity. Debentures may be secured (backed by a charge on the company's assets) or unsecured, and convertible (into equity shares after a specified period) or non-convertible. Because interest is a fixed, prior obligation and debenture holders rank above shareholders on winding up, debentures are considered safer but lower-return than equity shares. …