Capital Markets: A Complete Guide

Individuals, businesses, and governments buy and sell financial instruments on a platform called the capital market. Organizations can raise capital by selling securities to retail investors and financial institutions like banks.

Let us read more on ‘What is capital market?’, and more in detail.  Continue reading!

What is a Capital Market?

The capital market provides a platform for organizations to raise capital. The stock market, currency market, and bonds are a few examples of capital markets. Organizations use capital markets to raise funds to meet their financial requirements and run companies.

Buying and selling financial instruments like preference shares, bonds, equity shares, and debentures is easy in the capital market.   

Table of Content

1. What is a Capital Market?
2. Types of Capital Markets
3. How does the Capital Market work?
4. Example of Capital Market
5. Elements of Capital Market
6. Functions of Capital Market
7. End note

Types of Capital Markets

Capital markets can be categorized into two primary and secondary markets. Let us understand them in detail.

Primary Market

Also known as the ‘New Issues Market’, the primary market is the place where companies issue new shares or bonds. An initial public offering or IPO is raised to issue new stocks in the market. Stocks and debts are two financial instruments traded in the primary capital markets.

A company sells a portion of the ownership to the general public to raise money. Moreover, a company or government can issue bonds to raise funds for a specified period.

Secondary Market

Regulated by the Securities and Exchange Board of India (SEBI), the secondary market trades securities and bonds through the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE).

Investors use the secondary market to raise money to invest in stocks and other securities such as bonds. The secondary market operates under the guidelines provided by the SEBI promoting transparency, maintaining market integrity, and protecting investor interests.

How does the Capital Market work?

The capital market is a financial marketplace where companies, governments, and other organizations raise capital by issuing securities like stocks and bonds, while investors purchase these securities to earn returns. It serves two main functions: helping issuers raise funds for growth or projects and providing a platform for investors to buy and sell financial assets. 

The capital market consists of the primary market, where new securities are issued, and the secondary market, where existing securities are traded. This system facilitates the efficient flow of funds, supports economic development, and allows investors to diversify their portfolios.

Example of Capital Market

The capital market consists of various financial instruments and securities such as:

• Stock Exchanges

There are two types of stock exchange in India. Bombay Stock Exchange (BSE) and National Stock Exchange (NSE).

Bombay Stock Exchange (BSE): Founded in 1986, Bombay Stock Exchange is one of Asia’s oldest stock exchanges. It lists thousands of companies allowing trading in stocks, derivatives, and mutual funds.

National Stock Exchange (NSE): Founded in 1992, the National Stock Exchange is the largest stock exchange in India. The NIFTY 50 index is used in NSE to track the top 50 companies.

• Equity Market

The equity market is broadly divided into two types primary market and secondary market.

Primary Market: Companies issue their shares in the primary market for the first time through initial public offerings (IPOs) and follow-on Public Offerings (FPOs).

Secondary Market: Once the shares are issued in the primary market, these shares are then traded in the secondary market through NSE and BSE.

• Debt Market

The debt market is broadly categorized into two types corporate bonds and government securities. Corporate Bonds: It is issued by the companies to raise capital which can be traded later. Government Securities: To cover budget deficits, the government issues government securities such as long-term bonds, and treasury bills.

• Derivatives Market

Futures and Options: Future and options are based on contracts on assets like indices or stocks. Commodity Derivatives: these include future contracts for silver, gold, and agricultural products and traded on exchanges like NCDEX and MCX.

• Mutual Funds

Mutual funds are a pool of funds collected by funds houses from investors to buy a mix of bonds, stocks, and other assets.

• Foreign Portfolio Investment (FPI)

Foreign investors add liquidity in the market by investing in Indian stocks, bonds, and derivatives.

•  Alternative Investment Funds (AIFs)

Alternative investment funds cater to high-net-worth individuals and institutions including venture capital and private equity funds.

• Regulators

SEBI and RBI are two major regulators in India. SEBI is responsible for overseeing stock exchanges and mutual funds to protect investors. Whereas, RBI manages government securities and foreign exchange markets.

Elements of Capital Market

The following are the elements of the capital market:

• Individual investors, insurance companies, businesses, financial institutions, and retirement funds are the market sources of funds in the capital market.
• For investment to grow over time, investors invest to make capital gains receiving interest, dividends, and ownership.
• Companies, entrepreneurs, government, etc are the fund seekers who raise their funds in the capital market to meet various financial requirements.
• Usually, the market trades in long-term investments such as bonds, stocks, debentures, and government securities.
• SEBI monitors and eliminates any illegal activities in the capital market.

Functions of Capital Market

Below are the functions of the capital market:

• The capital market interlinks companies that sell their shares with traders and investors who buy these shares.
• Companies use capital market platforms to raise capital to meet their financial requirements.
• In the supervision of SEBI and RBI, the capital market offers a stable and systematic price of securities.
• The capital markets offer endless opportunities for investors to meet their demands with some risks.
• With a streamlined and automated trading process, the capital market reduces transaction time and cost.

End note

The capital market is an important pillar in the financial industry allowing companies and government entities to raise funds. These funds can be used to meet different financial requirements. On the other hand, investors can buy these issued shares to become shareholders of the company. Moreover, investors and traders can trade these shares to earn profit in the secondary market through NSE and BSE. Overall, it helps in the economic development of the country.