What Is a Capital Instrument?

Publicly traded corporations often turn to the capital markets in order to raise money for some designated purpose. These issuers could turn either to the debt or equity capital markets. A capital instrument is the financial security that is issued into the financial markets, and it may be an equity or debt share. When a company issues equity, it sells stocks in the markets. If that organization chooses to issue debt, it offers different types of bonds.

One type of a capital instrument could be an equity share that trades in the capital markets. Many shares are typically offered in a single issuance. These capital instruments provide investors with equity ownership in a corporation and a chance to share in profits. Also, investors become exposed to risk because there is no guarantee that the value of an equity share will rise. Possibly, a company may issue equity capital instruments in a debut trading session, known as an initial public offering (IPO), or in a secondary offering, when the entity seeks to raise additional capital for an expansion or some project, for instance.

A bond is a form of debt that represents another type of capital instrument. Bond issuers could be corporations or municipalities, for instance, and investors represent the lenders of this debt. Capital instruments in the debt market have interest rates attached that dictate the return that investors will earn on the allocation. Also, a time duration is joined to a bond, and this determines the period of time over which interest payments will be made to investors before the principal amount is returned. Investors may select short-term or long-term bonds that could vary from a period of three months to several decades.

It is possible for a new type of capital instrument to begin trading in the financial markets. The federal government in a region can participate in the trading environment by making certain requests for different capital instruments to be designed with a known amount of risk and likely reward, or profits, for investors. These financial securities might have unique characteristics, such as entering the markets as a security with debt-like features but later being converted into shares of equity that are designed to help a specific type of issuing entity, such as one that might be in financial distress. Investment bankers not only create these products but also must prove the merits of a new capital instrument to investors.