What is Capital Market? What are the Key Functions of Capital Markets?

What is Capital Market? What are the Key Functions of Capital Markets?
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Capital Market in India: An Overview

Any location or system that gives buyers and sellers the ability to exchange and trade in financial assets, such as bonds, shares, different international currencies, and derivatives, is referred to as a financial market. The connection between people with capital to invest and those who need capital is facilitated by these financial markets.  The Money Market and Capital Market together comprise the financial market. This article dives deep into the various aspects and details of the Capital Market.

What is Capital Market?

The Capital Market is a marketplace that acts as the meeting point for the suppliers and the interested parties in savings and investments. Suppliers referred to here are the parties that are willing to invest their capital or lend it to parties in need of such loans. These suppliers include banks and investors. In this market, companies, governments, and the general public are looking for funds. In technical terms, it is a place where buyers and sellers of financial securities meet to engage in trading these securities. Both individuals and institutions participate in the trading procedure. 

Primary and secondary markets make up capital markets. The stock market and the bond market are the two most popular capital markets. By connecting suppliers with people looking for money and offering a platform where they may trade securities, they aim to provide transactional efficiency. Most securities traded on the Indian capital market are long-term ones. Because the scale of a country's capital markets closely relates to the size of its economy, little movements in one area can have significant effects elsewhere.

Difference between Capital Market and Money Market

What is the difference between the capital market and the money market?

The main distinction is that capital markets are financial markets where long-term debt instruments are traded, while money markets are financial markets where short-term debt instruments are traded. Capital market instruments have a maturity of over one year, while money market instruments have a maturity of less than one year.

One example of a capital market is the New York Stock Exchange (NYSE). One example of money markets is called money markets.

Functions of Capital Market

  1. Formation of Capital: There are two types of individuals in the capital markets: investors who don't need money right away and debtors who do. The capital markets enable leftover funds to be invested and put to use rather than just hanging around. Therefore, it gives firms the chance to borrow money and invest in new machinery or other capital equipment rather than having ₹1 crore sitting in the locker. In exchange, the investor obtains a dividend and the company has access to more effective machinery. This capital market role looks at the economy at a macro level.
  2. Absence of Entry and Exit Barriers: Today's investors generally trade on the capital markets using their mobile devices, making them more accessible than ever. The spread of technology has virtually made financial markets accessible to everyone. Investors are practically prepared to invest as soon as they open an account with a broker. Additionally, there are now worldwide marketplaces. Due to the increased demand for assets, people can leave the market just as quickly as they entered.
  3. Economic Growth: The capital market promotes a marketplace for borrowers and lenders, which results in a more effective flow of cash. Businesses in need of corporate loans can apply on the capital market, and an underwriter will then issue the loan. As an alternative, it can raise money by offering a portion of its business on the stock market. Due to the fact that idle capital is put to use elsewhere in the economy, this promotes economic growth. Simply put, it increases demand. Businesses that require credit can make investments if they are granted it. The company that offers the capital equipment that it invested in receives that money in return. The economy can then continue to grow as a result of that money's circulation. This aspect is considered to be one of the most important roles of capital market.
  4. Capital Liquidity: People with money can invest it owing to the financial markets. They receive ownership of a bond or stock in exchange. However, they cannot use a bond certificate to purchase a car, food, or other assets, thus it could be essential to liquidate them. It is fairly simple for investors to sell their assets to a third party on the capital markets in exchange for liquid funds (cash). There is nearly always a buyer if one wishes to sell an item at the current market price, enabling you to convert the asset into actual cash.
  5. Price Regulation: Making sure the price of an asset is accurate is one of the capital markets' primary objectives. A share's price may spike after receiving favorable news or plunge after reading an unsatisfactory annual report. The prices fluctuate to the point where the equity worth is represented in its price at that moment due to the thousands of traders. Bond prices can change and adapt more quickly as a result of supply and demand at the same time. For instance, during a recession, investors typically choose bonds since they are perceived as a safer investment.
  6. Provides Opportunity to Investors: If an investor wants a high level of risk or a low level of risk, there are enough financial instruments available in the capital markets to fit their needs. At the same time, capital markets give investors a chance to increase their capital yield. Savings accounts pay very little interest, especially when compared to the rates on most equities. Therefore, the capital market offers investors the chance to earn a higher rate of return, though there is also some risk involved. This function of capital market stands in the favour of the investors participating in it.

Example of Capital Market: Capital market instruments

There is a capital market instrument for every form of investment. The most common instruments in the capital markets include the bond market, stock market, money market, and derivatives market.

A bond Market is a financial institution that specializes in raising funds by issuing debt securities such as bonds. Corporations or governments usually issue bonds to fund projects such as dams, roads, or bridges, buying equipment, etc.

A stock Market is an organized marketplace where stockholders buy or sell shares of a company's securities through brokers/dealers who act as intermediaries between buyers and sellers.

Money Market is where short-term loans (under one year) are made to corporations and businesses at lower rates than those charged by banks for long-term loans because money markets have high liquidity (they can be easily liquidated).

What Is a Primary vs. Secondary Market?

A primary market is raising capital by issuing securities for the first time. In other words, it's when companies go to banks or investors and ask for money to invest in their business.

A secondary market is a process of buying and selling existing securities. So if you hold a share in a company, you can sell it on the stock exchange to another person who wants to buy it from you at a price you agree upon (or is set by auction).

In a primary market, investors buy shares from the company. In a secondary market, existing shareholders sell their shares to other people.

The difference between a primary and secondary market can be confusing, especially for beginners. You might wonder why companies want to raise money by selling existing shares instead of issuing new ones. But there are good reasons for this. If you've ever bought or sold stocks, then you know that they can be pretty volatile—the price fluctuates according to how investors feel about the company at any given time.

Structure of Capital Market in India

The structure of the Indian Capital Market can be described by using the following heads:

  1. Market: Capital Markets are categorized into two components of capital market:
    1. Primary Markets: New securities that are originally launched on the stock market are primarily the focus of the primary market. As a result, the fresh issue market is another name for it. The primary market's fundamental purpose is to make it easier for businesses to transfer freshly issued shares to the general public. Financial institutions, banks, HNIs, and others are the key investors in this sort of market.
    2. Secondary Markets: The auction market and the dealer market are the two distinct subcategories of the secondary market. The open outcry mechanism, where buyers and sellers gather in one place and call out the prices at which they are ready to purchase and sell their assets, is specific to the auction market. Examples of such capital markets in India include the National Stock Exchange and the Bombay Stock Exchange. However, in dealer markets, commerce occurs across electronic networks. The majority of small investors transact on dealer marketplaces.
  2. Instruments: There are five types of instruments in the capital markets in India:
    1. Equities: The net difference between a company's total assets and its total liabilities is known as a company's equity or shareholders' equity. When a corporation has publicly traded stock, its market capitalization may be determined by multiplying the share price by the number of outstanding shares.
    2. Debt Securities: Financial instruments known as debt securities give their owners the right to receive regular interest payments. Debt securities, in contrast to equity securities, call on the borrower to pay back the principal amount borrowed. The perceived creditworthiness of the borrower will have an impact on the interest rate for a debt instrument.
    3. Hybrid Securities: A single financial security called hybrid security combines two or more distinct financial instruments. Often referred to as "hybrids," hybrid securities typically incorporate both loan and equity features.
  3. Regulator: The Securities and Exchange Board of India (SEBI) is a government agency that, among other responsibilities, regulates the capital markets to protect investors from fraud. Regulation refers to the actions taken by government-instituted regulatory bodies to monitor, manage, and oversee capital market processes. It is the only body that acts as a regulator in the Indian Capital Market.

Which Markets Do Firms Use to Raise Capital?

The main markets firms use to raise capital are the equity, debt, and money markets.

When a firm wants to raise funds by issuing new shares or bonds, it can do so directly on the stock market or via a financial intermediary such as an investment bank (e.g., Rothschild). In some cases, companies also issue securities in private placements where only institutional investors buy these issues.

The main reason for issuing shares is to raise capital. Companies usually issue new shares when they need to finance an expansion or diversification of their operations. They can also use share issues to reward employees, takeovers, and corporate restructurings.

Are Capital Markets the Same as Financial Markets?

Capital markets are not the same as financial markets.

Financial markets involve buying and selling assets, such as stocks, bonds, and currency. Capital markets are part of the financial market. They allow companies to raise capital from investors by issuing shares.

The two most important capital markets are -Primary markets: These allow companies to issue new shares and debt for the first time. They also allow investors to trade existing shares and debt. For example, when a company wants to raise money by issuing new shares, it will launch an Initial Public Offering (IPO). When a company wants to issue bonds, it will usually do so through one of the many bond markets

-Secondary markets: These allow investors to trade existing shares and debt. For example, when a company wants to sell its shares on the stock market or investors want to sell bonds, they will go through one of the many secondary markets.

  • How do Capital Markets Work?

  • How is the Capital Market different from the Money Market?

  • How do companies raise capital from the Capital Market?

  • What are the intermediaries of the Capital Market?

  • What is the primary function of capital?

  • What is the importance of a market?

  • What is a vital principle of a market economy?

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