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What is Financial Security or Financial instrument?

A financial instrument or financial security is a tradable (i.e. can be bought and sold in
financial market , e.g. stock market) certificate, which includes certain terms and
conditions that legally bind both the party involved in trade to abide by the terms stated
in instrument.

A financial Security can represent an ownership position in a publicly-traded corporation

(PLC). Such security is called Equity Security. By selling i.e. issuing equity securities to
investors, PLC’s raise equity or owner’s capital (also known as permanent capital) for
the business. The two types are:
 Common stock or Ordinary Share (holder of stock get usually 1 vote per
share to elect BOD, receives dividend)
Preferred stock (doesn’t have voting right, get fixed dividend)

A Financial Security can also represent a creditor relationship (lender –borrower

relationship). This type of security is called Debt security. By selling i.e. issuing debt
securities to investors PLC’s, Government or other entity raises debt or loan capital from
investors (buyers of this security) on a short-term or long-term basis. So, there are
(I)short-term debt security (i.e. loan or debt capital obtained and has to be paid back with
interest within 1 year) and (ii)(long-term debt security (i.e. loan or debt capital obtained
and has to be paid back with interest after1 year)
Notes (Short-term debt security. <1 year)
Bonds (Long-term debt security. >1 year) 2
Debentures (Long-term debt security. > 1 year)
FINANCING THE BUSINESS
Equity financing is money acquired from the owners
themselves or from other investors in exchange for ownership
in a company. New businesses can use equity financing for
their startups. When corporations need to raise additional
equity capital for supporting company activities they obtain
fund by selling common or preferred stock to individual or
institutional investors. In return for the money paid,
shareholders receive ownership interests in the corporation.
Debt Financing
Debt Financing is the act of raising money for company
activities by borrowing short-term or long-term loan from bank
or by selling bonds, bills, or notes to individual and/or
institutional investors. Individuals or institutions who lend
money or buy bonds or notes or bills become creditors and
they receive a promise that the principal and interest on the
debt will be repaid by the company.
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FINANCING THE BUSINESS
To initiate or start a business, whether it is proprietorship,
partnership, private or public limited company, any business
firms need capital or fund to invest in assets and to run its
operations. This chapter deals with the ways or the means
though which firm of different types raises startup or initial
capital and also additional working capital to support
ongoing business operations.
Proprietorship or Partnership

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Proprietorship or Partnership
Once the business is established the firm (proprietorship or
partnership) may need additional fund:
To run and support day to day operations
For expansion of business
For acquiring or purchasing fixed assets.

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PRIVATE LIMITED COMPANY: Characterized by minimum 2 and
maximum 50 shareholders who are owners or equity capital providers or founders
of business. Shareholders investment in firm is determined by Authorized Capital
(amount of share capital a firm can utilize in business) and the value of each share
stated in the firm’s Memorandum of Association.

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PUBLIC LIMITED COMPANY
Generally characterized by minimum 7 and maximum any number
of shareholders (owners or equity capita providers). Shareholders
investment and maximum number of shareholders is determined
by the amount of Authorized Capital and the face value of each
share stated in the Memorandum of Association of the company.
PLC’s are allowed to issue a prospectus in primary market,
which invites public to buy the company’s securities such as stock
or bond.
Public will not be interested to give fund to the company by
buying its stock or bond from the primary market, if they cannot
sell the company’s stock or bond they own when in need of
money.
So, PLC’s are allowed to get enlisted with SEC (Securities
Exchange Commission) which allows the company to trade (buy
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or sell) its stock or bond in stock exchange or secondary market.
PUBLIC LIMITED COMPANY
PLC can also raise initial or new capital by borrowing loan
capital (in addition to owner’s capital). Such as short-term or
long term bank loan or by issuing debt obligations also
known as debt instruments or certificates such as bond or
debenture

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PUBLIC LIMITED COMPANY

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Financial Market
Financial market contains both suppliers of fund and borrowers of fund.
The financial market is composed of a number of financial institutions (such
as banks, investment intermediaries, insurance companies) also known as
financial intermediaries that pool resources and channel funds from savers
or lenders to spenders or borrowers. Smooth functioning of these
institutions is very important for an efficient financial market and for the
conduct of fiscal and monetary policies.

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FINANCIAL MARKET
Money Market: is for short term financial securities (with
maturity < 1 year)

Capital Market: is for long term financial securities (with maturity

> 1 year)

Primary market: In primary market new issues of financial

securities like bond or stocks are sold to initial buyers (investment
banks underwrites i.e. act as medium to sell new issue of
securities to the public). The first sale of stock by a private
company to the public in the primary market is known as IPO
(Initial Public Offering).

Secondary Market: In secondary market Securities previously

issued are traded that is bought and sold (with the help of brokers
and dealers)
NOTE: Debt securities (like bills, notes or bonds) belong to both
money and capital market, depending on their period of maturity.11
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 Flow of Funds
1. Indirect finance is where borrowers borrow funds from the
financial market through indirect means, such as through a
financial intermediary. A financial intermediary stands
between savers/lenders and spenders/borrowers—financial
intermediary obtains surplus funds from savers and lends
them to borrowers of its choice.
A commercial bank is a common example of a financial
intermediary—a commercial bank receives savings and
deposits from individuals, and uses them, for instance, to
give loans. There are a large number of financial institutions
that serve as financial intermediaries (depository institutions,
investment intermediary etc) such as mutual funds, pension
funds, insurance companies buy stocks and bonds.

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2. Direct finance is a method of financing where borrowers
borrow funds directly from the financial market without using
a third party service, such as a financial intermediary. Direct
financing is usually done by borrowers that sell securities
(stock or bond) to raise money and avoid the high interest
rate of financial intermediary (e.g. banks).

Common methods for direct financing include a financial

auction or an initial public offering (IPO) of a corporation
where the investor buys a new issue of securities (stock or
bond) directly from the company. In direct finance, lenders
lend to borrowers directly.
A saver, for example, has $10,000 saved and buys a $10,000
Banglalink Corporate Bond maturing in ten years which pays
an interest rate of 10% percent per annum—in this
transaction, the saver has essentially directly lent $10,000 to
Banglalink for ten years.
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FACTORS AFFECTING CHOICE OR SOURCE OF FINANCE
Availability of different sources of capital for the firm. Such
as debt or equity.
Relative cost of different sources of capital ( interest to be
paid on loan or dividend to be paid to stockholders).
Consequences of control of the business that means
whether or not the founders of the business want others
involvement in decision making.
The implications for shareholders dividends that means
whether or not the founders of the business want to share
profit with the shareholders.
Tax implications. Since interest on debt is tax deductible
expense, it reduces the company’s taxable income. So debt
capital have tax benefit.
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FACTORS OF AFFECTING CHOICE OF FINANCE
 The risk element involved. Risky projects should be
financed by equity capital. If risky ventures financed by debt
turned out to be unprofitable in that case the creditors may
force the company to liquidate to fulfill their claims.

 Terms and repayment period of loan capital.

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Why are Secondary markets (stock exchange) important?
 Secondary market makes financial instruments (e.g. stock
or bond) more liquid. It becomes easier to convert those
financial instrument or securities into cash.
Due to liquidity of the financial instruments in secondary
market, they become more desirable to investors or general
people.
The trading of company’s stock or bond in stock exchange
make it easier for the company to sell their shares in the
primary market to general public.

Secondary market helps in determining the price of the

financial instruments (stocks, bonds, debentures) that will be
paid in the primary market by initial buyers. So secondary
market has impact on the amount of capital that can be raised
by the firm.
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What Are Money Market Securities?
Money market securities are short term debt securities having maturity
period of 12 months or less are issued and traded in the money market.
What Type Of Securities / Investment Instrument Are Traded In The Money
Market?
The extensive variety of securities traded in the money market include
those issued by:-
The Government
Government agencies
Banks and
Corporations

What Financial Entities Participate In The Money Market?

Participants in the money market include:
The central bank
 Banks
Security dealers
Corporations. 24
What financial goals can be achieved through investing in money
market?
For those seeking a place where they may borrow money or lend
excess fund for short periods of time, the money market provides a
useful trading venue. The vast majority of investors in these
money market securities are institutions and very few are
individuals. Here funds may be invested or borrowed for as little as
overnight or as long as a year. This is a place for large institutions
and government to manage their short term cash needs.

What type of securities / investment instrument are traded in the money

market?
Money market securities or instrument are:
 Government treasury bills
 Negotiable certificate of deposits
 Commercial paper
 Repurchase agreement
 Banker’s acceptance
 Money market mutual funds
 Eurodollars
 Federal funds 25
 Capital Market Financial Instruments
The financial instruments or securities with maturity greater
than 1 year are mainly issued and traded in the capital
market. Examples are:
Corporate stocks
Corporate bonds
Government bonds
Bank commercial loans
Residential mortgages
Consumer loans
Commercial mortgages
Marketable long-term government securities.
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Financial Market of Bangladesh
1. Money Market: The Primary Money Market is comprised of Banks, Financial
Institutions and primary dealers (bank & non-bank FI) as intermediaries. The
only active Secondary Money Market is Overnight Call Money market which is
participated by the scheduled banks and Financial Institutions. The money
market in Bangladesh is regulated by Bangladesh Bank. At present, Savings
& lending instruments, government treasury bills of varying maturity,
Bangladesh Bank Bills and Certificates of Deposits etc in limited supply are
available for trading in the money market
Call Money Market It is an inter-bank market where the banks in temporary deficit
of cash resorted to borrowing from other banks having surplus funds. The
transactions of call money market usually take place on the basis of bilateral
negotiations. Since call loans are made on clean basis, ie, without any
security, lending institutions/banks are always cautious in the selection of
borrowing banks/institutions.
Bill Market is restricted to buying and selling of government treasury bills. In the
past, it was basically concentrated in transaction of government treasury bills
of 3-month maturity at predetermined rates. Commercial banks were obliged
to buy these bills as approved security to meet their statutory liquidity
requirement (SLR) under the Banking Companies Act.
The commercial bill market remained very narrow in the country largely due to
slow growth of trade and commerce. Banks traditionally financed two broad
categories of commercial bills viz. inland bills and export bills. 27
Financial Market of Bangladesh
2. Capital market: The capital market in Bangladesh is governed by Securities and
Exchange Commission (SEC). The primary capital market is operated through
private and public offering of equity and bond instruments. The secondary capital
market is institutionalized by two stock exchanges-Dhaka Stock Exchange and
Chittagong Stock Exchange. The instruments traded in these exchanges are
equity securities (shares), debentures, corporate bonds, treasury bonds and
mutual funds. As on November 2011, the numbers of common share are 232 in
DSE which are gradually increasing. The Dhaka stock exchange introduced
Mutual funds operation in 1980.Now, as on November 2011, the numbers of Mutual
funds share are 37 in DSE which are gradually increasing.

The bond market is dominated by the fixed income government debt instruments.
The maximum savings of small investors are mobilized by only one instrument
name National Saving Certificate. The interest on this saving certificate is higher
than that of other bonds in the market. Besides the national saving certificate, the
other government debt instruments are treasury bills and treasury bonds. There
are 5, 10, 15 and 20 years maturity treasury bond. Bank and financial institutions
are the main buyers of treasury bonds. Commercial banks have obligation to
purchase government securities as it is accepted as security to meet their
statutory liquidity requirement (SLR) under the Banking Companies Act. This is
still a small market. Banks and financial institutions which have SLR obligations
are the only participants in this market. The government bonds are rarely traded
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on the stock exchanges.
The corporate bond issues had been very occasional and had been stagnant due
to a lack of varied corporate debt supply. This is because, in general, companies
prefer to rely on banks for funds rather than on the bond market, thereby avoiding
the need to comply with disclosure and governance norms. As on November,
2011, only eight debentures exist in the Dhaka stock exchange. No new debenture
was issued after 1999. Besides these, ten debentures already went to maturity.
Only three corporate bonds are trading in the capital market (CSE & DSE) which
are IBBL Mudaraba perpetual bond, ACI zero coupon bond & Subordinated bond
of BRAC Bank.

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