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HomeFinanceFinancial RiskThe role of investment trusts in the capital market

The role of investment trusts in the capital market

The capital market enables individuals and organisations with spare capital (money which they want to invest) to channel these funds to businesses and other organisations that need investment capital (money for expansion or other purposes). This case study explains the operation of Investment Trusts, which are a key part of the market.

The role of investment trusts in the capital market

The need for funds

Businesses sometimes need funds above the income they get from trading to help them grow and also carry out their day-to-day trading activities. Businesses acquire funds from several sources:

  • shareholder capital – where investors give the company money in exchange for shares (long-term)
  • loan capital (medium-term)
  • bank overdrafts and trade credit (short-term).

This study concentrates on longer-term funds. Without long-term funds, businesses would struggle to buy expensive capital equipment, build new premises, expand into foreign markets, or acquire other businesses.

Investment Trusts as sources of funds

Investment Trusts provide invaluable funds to businesses by acting as intermediaries. They channel funds from financial institutions and households to businesses through the Stock Market and these funds can help businesses grow and expand.

Investment Trusts provide their investors with investments tailored to investors’ individual requirements eg the degree of risk an investor is willing to take and the rate of return he/she expects. Investors aim to gain from holding Investment Trusts in two ways:

  • they often receive a dividend – their share of the profit earned by the Investment Trust in a given period eg 6 months or a year
  • the value of their investment may grow over time if the share prices of the companies in which they have invested go up, particularly if their Investment Trust has invested for growth. However, the value of investments can go down as well as up, and this is the risk that Stock Market investors take.