Control Market Instruments
by
Charles Lamson
The capital market is extremely important because it raises the funds needed by deficit spending units (DSUs) to carry out their spending and investment plans. A smoothly functioning capital market influences how fast the economy grows.
Stocks
Stocks are equity claims representing ownership of the net income and the assets of a corporation. The income that stockholders receive for their ownership is called dividends. Preferred stock pays a fixed dividend, and in the event of bankruptcy of the corporation, the owners of preferred stock are entitled to be paid first, after the corporation's other creditors. Common stock pays a variable dividend, depending on the profits that are left over after preferred stockholders have been paid and retained earnings set aside. The largest secondary market for outstanding shares of stock is the New York Stock Exchange. Several stock indexes measure the overall movement of common stock prices; the Dow Jones Industrial Average, perhaps the best known, is based on the prices of only 30 stocks while the Standard & Poor's 500 Stock Index is based in the prices of 500 stocks. The amount of new stock issues in any given year is typically quite small relative to the total value of shares outstanding.
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Mortgages
Mortgages are loans to purchase single (or multiple) family residential housing, land or other real structures, with the structure or land serving as collateral for the loan. In the event the borrower fails to make the scheduled payments, the lender can repossess the property. Mortgages are usually made for up to 30 years, and the repayment of the principal is generally spread out over the life of the loan. Some mortgages charge a fixed interest rate that remains the same over the life of the loan; others charge a variable interest rate, that is adjusted periodically to reflect changing market conditions. Savings and loan associations and mutual savings banks are the primary leaders in the residential mortgage market, although commercial banks are now also active lenders in this market.
Corporate Bonds
Corporate Bonds are long-term bonds issued by usually (although not always) with excellent credit ratings. Maturities range from 2 to 30 years. The owner receives an interest payment twice a year and the principal at maturity. Because the outstanding amount of bonds for any given corporation is small, corporate bonds are not nearly as liquid as other securities such as U.S. government bonds. However, an active secondary market has been created by dealers who are willing to buy and sell corporate bounds. The principle buyers of corporate bonds are life insurance companies, pension funds, households, commercial banks, and foreign investors.
U.S. Government Securities
U.S. government securities are long-term debt instruments with maturities of 2 to 30 years issued by the U.S. Treasury to finance the deficits of the federal government. They pay semiannual dividends and return the principal at maturity. An active secondary market exists, although it is not as active as the secondary market for T-bills. Despite this, because of the ease with which they are traded, government securities are still the most liquid security traded in the capital market. The principal holders of government securities are the Federal Reserve, financial intermediaries, securities, dealers, households, and foreign investors. 
U.S. Government Agency Securities
U.S. government agency securities are long-term bonds issued by various government agencies, including those that support commercial, residential and agricultural, real estate, lending, and student loans. Some of these securities are guaranteed by the federal government, and some are not, even though all of the agencies are federally sponsored. Active secondary markets exist for most agency securities. Those that are guaranteed by the federal government function much like U.S. government bonds, and tend to be held by the same parties that hold government securities.
State and Local Government Bonds (Municipals)
State and local government bonds (municipals) are long-term instruments issued by state and local governments to finance expenditures on schools, roads, college dorms, and the like. An important attribute of municipals is that their interest payments are exempt from federal income taxes and from state taxes for investors living in the issuing state. Because of their tax status, state and local governments can issue debt at yields that are usually below those of taxable bonds of similar maturity. they carry some risk that the issuer will not be able to make scheduled interest or principal payments. Payments are generally secured in one of two ways. Revenue bonds are used to finance specific projects, and the proceeds of those projects are used to pay off the bondholders. General obligation bonds are backed by the full faith and credit of the issuer; taxes can be raised to pay the interest and principal on general obligation bonds.
*SOURCE: THE FINANCIAL SYSTEM & THE ECONOMY, 3RD ED.,2003, MAUREEN BBURTON & RAY LOMBRA, PGS. 114-117*
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