The capital market is the sector of the financial market where long-term financial instruments issued by corporations and governments trade. Here “long-term” refers to a financial instrument with an original maturity greater than one year and perpetual securities (those with no maturity). There are two types of capital market securities: those that represent shares of ownership interest, also called equity, issued by corporations, and those that represent indebtedness, issued by corporations and by the U.S., state, and local governments.
Earlier we described the distinction between equity and debt instruments. Equity includes common stock and preferred stock. Because common stock represents ownership of the corporation, and because the corporation has a perpetual life, common stock is a perpetual security; it has no maturity. In later chapters we describe common stock in more depth. Preferred stock also represents ownership interest in a corporation and can either have a redemption date or be perpetual.
A capital market debt obligation is a financial instrument whereby the borrower promises to repay the maturity value one year after issuance. These debt obligations can be broken into two categories: bank loans and debt securities. While at one time, bank loans were not considered capital market instruments, in recent years a market for the buying and selling of these debt obligations has developed. One form of bank loan that is bought and sold in the market is a syndicated bank loan. This is a loan in which a group (or syndicate) of banks provides funds to the borrower. The need for a group of banks arises because the amount sought by a borrower may be too large for any one bank to be exposed to the credit risk of that borrower.
Debt securities include (1) bonds, (2) notes, (3) medium-term notes, and (4) asset-backed securities. The distinction between a bond and a note has to do with the number of years until the obligation matures when the security is originally issued. Historically, a note is a debt security with a maturity at issuance of 10 years or less; a bond is a debt security with a maturity greater than10 years.
The distinction between a note and a medium-term note has nothing to do with the maturity, but rather the way the security is issued. Throughout most of this book, we refer to a bond, a note, or a medium-term note as simply a bond. We will refer to the investors in any debt obligation as either the debtholder, bondholder, or noteholder. In Chapter 19, we describe the features and types of bonds.