In the previous weeks, we introduced the capital market and the key players that keep it running.
Now it’s time to understand what is actually traded in the market.
These tradable assets are called financial instruments.
Financial instruments.
Financial instruments are the assets investors buy and sell in the capital market. They are also the tools that companies and governments use to raise money for growth and development.
If you want to understand investing, you must first understand these instruments.
What Are Financial Instruments?
A financial instrument is any asset that can be traded or exchanged in financial markets.
In simple terms, they are contracts that represent money, ownership, or a claim on assets.
Examples include:
- Stocks (Shares)
- Bonds
- Treasury Bills
- Commercial Paper
- Mutual Funds
- Exchange-Traded Funds (ETFs)
- Derivatives
Financial instruments generally fall into two major categories:
- Equity instruments
- Debt instruments
Each serves a different purpose.
Equity Instruments
Equity instruments represent ownership in a company.
When you invest in equity, you become a shareholder, meaning you own a portion of that company.
The most common equity instrument is stocks (shares).
What Are Stocks (Shares)?
A stock or share represents ownership in a company.
When a company wants to raise money to grow its business, it can issue shares to the public through the stock market.
When you buy shares:
- You become a part-owner of the company
- You may receive dividends
- The value of your shares may increase or decrease depending on the company’s performance
For example:
If you buy shares in a Nigerian company listed on the Nigerian Exchange Group, you now own a small percentage of that company.
Types of Equities
There are several terms used to describe equities. Beginners often confuse them, but they simply describe how or where shares are traded.
Quoted Equities
Quoted equities are shares whose prices are publicly quoted on a stock exchange.
This means investors can see their market price during trading hours.
For example:
When the price of a company’s shares appears on the stock exchange trading board, those shares are quoted equities.
Listed Equities
Listed equities are shares that have been officially admitted to trade on a stock exchange.
For a company to list its shares, it must meet strict requirements set by regulators and the exchange.
Once listed, the company’s shares can be traded by investors.
All listed equities are quoted, but not all quoted securities must necessarily be actively traded.
Dividends
One of the main benefits of owning shares is receiving dividends.
A dividend is a portion of a company’s profits distributed to shareholders.
When a company performs well financially, it may decide to share some of its profits with investors.
Dividends can be paid:
- Quarterly
- Semi-annually
- Annually
However, not all companies pay dividends. Some prefer to reinvest profits back into growing the business.
Capital Gains
Another way investors make money from shares is through capital gains.
Capital gain occurs when:
You buy a share at a lower price and sell it later at a higher price.
Example:
- You buy a share for ₦100
- The price rises to ₦150
- Your capital gain is ₦50
This price increase usually happens when the company performs well or when demand for its shares increases.
Debt Instruments
Unlike equity instruments, debt instruments do not give you ownership in a company.
Instead, they represent money that you lend to a company or government.
In return, the borrower agrees to:
- Pay interest
- Repay the original amount at maturity
The most common debt instruments include:
- Bonds
- Treasury Bills
- Commercial Paper
Bonds
A bond is a financial instrument used by governments or companies to raise long-term funds.
When you buy a bond, you are lending money to the issuer.
In return, the issuer promises to:
- Pay periodic interest
- Return your original investment at maturity
Bonds are generally considered less risky than stocks but they usually provide lower returns.
Types of Bonds
There are several types of bonds investors may encounter.
Government Bonds
These are bonds issued by the government to finance public projects such as:
- Infrastructure
- Roads
- Schools
- National development
Government bonds are generally considered low-risk investments because they are backed by the government.
Corporate Bonds
Corporate bonds are issued by companies that need funding for expansion or operations.
They usually offer higher interest rates than government bonds, but they also carry slightly higher risk.
Municipal Bonds
Municipal bonds are issued by local governments or municipalities to fund community projects such as:
- Public transportation
- Hospitals
- Water systems
Commercial Paper
Commercial paper is a short-term debt instrument issued by companies.
It is typically used by businesses to finance short-term operational needs, such as:
- Paying suppliers
- Managing working capital
- Covering immediate expenses
Commercial paper usually matures within 270 days or less.
Because it is short-term, it is often used by large, financially stable companies.
Treasury Bills
Treasury Bills (T-bills) are short-term government securities used to raise money for government operations.
They usually mature within:
- 91 days
- 182 days
- 364 days
Treasury bills are considered one of the safest investments because they are backed by the government.
Collective Investment Instruments
Another important category of financial instruments is collective investment instruments.
These allow multiple investors to pool their money together and invest in diversified portfolios.
Mutual Funds
A mutual fund is a financial instrument that pools money from many investors and invests it in a diversified portfolio of assets such as stocks, bonds, or money market instruments.
Instead of buying individual investments yourself, your money is managed by professional fund managers.
These managers decide:
- What securities to buy
- When to buy or sell
- How to balance risk and return
This makes mutual funds a popular option for beginner investors who may not have the time or expertise to manage investments themselves.
How Mutual Funds Work
Here is a simple example.
Imagine:
- 10,000 investors each invest ₦50,000
- The total pooled money becomes ₦500 million
A professional fund manager then invests that money into different assets such as:
- Stocks
- Bonds
- Treasury bills
- Other securities
Because the fund invests in many assets, it spreads risk across multiple investments.
This is called diversification.
Types of Mutual Funds
There are several types of mutual funds, depending on what they invest in.
Equity Funds
These funds invest mainly in stocks.
They offer higher growth potential but also carry higher risk.
Suitable for:
- Long-term investors
- Investors seeking capital growth
Bond Funds
Bond funds invest primarily in government or corporate bonds.
They tend to provide stable income through interest payments.
Suitable for:
- Conservative investors
- Income-focused investors
Money Market Funds
These funds invest in short-term instruments, such as:
- Treasury bills
- Commercial paper
- Bank deposits
They are considered low-risk investments.
Suitable for:
- Capital preservation
- Short-term savings
Balanced (Hybrid) Funds
Balanced funds invest in a mix of stocks and bonds.
The goal is to combine growth potential with stability.
Suitable for:
- Investors seeking moderate risk
- Diversified exposure
Advantages of Mutual Funds
Mutual funds offer several benefits to investors.
Professional Management
Experienced fund managers handle investment decisions.
Diversification
Your money is spread across multiple assets, reducing risk.
Accessibility
Many mutual funds allow investors to start with relatively small amounts.
Liquidity
Investors can usually buy or sell units of the fund easily.
Mutual Funds vs Stocks
| Feature | Stocks | Mutual Funds |
|---|---|---|
| Ownership | Direct ownership in one company | Ownership in a pooled investment fund |
| Risk | Higher risk | Lower risk due to diversification |
| Management | Self-managed | Managed by professionals |
| Diversification | Requires buying multiple stocks | Built-in diversification |
Exchange-Traded Funds (ETFs)
Another financial instrument similar to mutual funds is an Exchange-Traded Fund (ETF).
ETFs also hold a basket of assets, but unlike mutual funds, they are traded on the stock exchange just like regular shares.
This means investors can buy and sell ETFs during market hours.
Where Mutual Funds Fit in the Capital Market
Mutual funds are an important part of the capital market because they:
- Allow small investors to participate in large portfolios
- Improve market liquidity
- Encourage long-term investing
- Provide professional portfolio management
Comparing Major Financial Instruments
| Instrument | Ownership | Risk Level | Return Type |
|---|---|---|---|
| Stocks | Ownership in a company | Higher risk | Dividends & capital gains |
| Bonds | Loan to government/company | Moderate risk | Interest |
| Treasury Bills | Loan to government | Low risk | Interest |
| Commercial Paper | Short-term corporate loan | Moderate risk | Interest |
| Mutual Funds/ ETFS | Pooled Investments | Varies | Income and capital growth |
Each instrument plays a different role in a well-balanced investment portfolio.
Why Financial Instruments Matter
Financial instruments make the capital market work.
They allow:
- Companies to raise capital
- Governments to finance development
- Investors to grow wealth
- Markets to allocate resources efficiently
Without financial instruments, the capital market would not function.
Beginner Takeaway
If you are new to investing, remember this simple framework:
Equity instruments = ownership (stocks).
Debt instruments = lending money (bonds, treasury bills, commercial paper).
Funds = pooled investments (mutual funds, ETFs)
Understanding these categories is the first step toward making informed investment decisions..
