Capital Market: Meaning, Structure, Instruments, Roles & More

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Capital Market
Capital Market

The Capital Market, as a crucial segment of the financial market, is integral for channeling capital between investors and borrowers. Understanding the its functioning is essential for developing a grasp of the Indian Financial System. This article of NEXT IAS aims to study in detail the Capital Market, including its meaning, components, structure, types, roles, regulations, and other related concepts.

Capital Market
  • Capital Market refers to that part of the broader financial market which provides a market for borrowing and lending of medium and long-term funds, above 1 year.
    • Thus, it caters to the borrowing needs for medium to long term projects and investments.
  • Because of the long maturity period, the Capital Market facilitates the mobilization and allocation of long-term funds.
Financial Market is a broad term, referring to any center or arrangement where buyers and sellers participate in the trade of financial claims such as equities, bonds, currencies, and derivatives.
– The Financial Market is classified into two categories.
A. Money Market – Market for trading short-term financial assets with a maturity of upto 1 year
B. Capital Market – Market for borrowing and lending of medium and long-term funds, above 1 year.

The capital market is a complex system, formed by various components. Various components and structure of capital market can be classified into the following 3 categories.

Capital Market participants include the individuals and institutions that interact within the market. These participants can be, broadly, categorized into 2 groups:

  • Investors or Suppliers of Capital: These are entities with surplus funds and are looking to invest. They include individuals, pension funds, insurance companies, and commercial banks.
  • Borrowers or Issuers of Securities: These are entities that raise funds by issuing various types of securities. They include businesses looking to expand, governments financing projects, and individuals seeking loans.

Capital Market Instruments or the Instruments of Capital Market refer to various types of financial tools used within the market. They include financial securities and derivatives that serve as mediums and facilitate the flow of money among the participants of the capital market.

Various capital market instruments can be, broadly, classified into the following types:

  • Share or Stock
  • Debt Instruments
  • Derivatives
  • Mutual Funds
  • Exchange Traded Funds (ETFs)
  • Instruments of Foreign Investments

Each type of capital market instrument has been discussed in detail in our article Instruments of Capital Market.

Capital Market Infrastructure refers to the institutions that facilitate the smooth operation of the market. These institutions play a crucial role in connecting various participants and ensuring their regulated interactions for trading through instruments available in the market.

Major types of institutions forming part of the capital market infrastructure are as follows:

  • Stock Exchanges: Stock exchanges are essentially marketplaces for buying and selling financial instruments. They act as a central platform where investors and companies connect.
    • Various concepts regarding Stock Exchanges have been dealt with in detail below.
  • Regulatory Bodies: These organizations ensure fair and transparent practices within the market. Major regulators involved in regulation of Capital Market in India are:
    • Securities and Exchange Board of India (SEBI)
    • Reserve Bank of India (RBI)
    • Union Ministry of Corporate Affairs, and
    • Department of Economic Affairs, Union Ministry of Finance.
  • Financial Intermediaries: These institutions connect investors with those seeking capital.
    • Brokers, investment banks, and underwriters are some examples.

Based on the type of securities traded, the Capital Market is of 2 types:

  • The Primary Market is the type of Capital Market where new securities are issued for the first time.
    • Thus, it is also called the New Issue Market.
  • The primary market provides the channel for the sale of new securities. The issuer of securities sells the securities in the primary market to raise funds for investment and/or to discharge.
    • In other words, the market wherein resources are mobilized by companies through the issue of new securities is called the primary market.
  • The Secondary Market refers to a market where those types of securities are traded, which have already been issued and offered to the public in the Primary Market and/or listed on the Stock Exchange.
    • Thus, it is also called the Old Issue Market.
  • The secondary market enables securities holders to adjust their holdings in response to changes in their assessment of risk and return or to buy/sell their securities as per their liquidity needs.
Primary MarketSecondary Market
New market securities are sold.Only existing securities are traded.
Investors have the option of only buying the securities.Investors can both buy and sell securities.
The price of securities is mostly decided by the management of the issuing company.The price of securities is determined by the demand and supply of the market.
Primary Markets have no fixed geographical location.Secondary Markets are located at specified places, known as Stock Exchange.
Major intermediaries – Merchant Banks, Underwriters, Debenture Trustees, Portfolio Managers, etc.Major intermediaries – Brokers, Jobbers, etc.

The functioning dynamics of both types of markets are discussed in detail in the sections that follow.

The issue of new securities in the Primary Market occurs through various methods as discussed below.

Public Issue or Public Offering

  • Public Issue or Public Offering refers to the process of a company offering its securities (usually stocks or bonds) for sale to the general public for the first time or subsequently.
  • It is the usual way through which companies raise capital from a broad range of investors.
  • There are 2 main types of public issues:
Initial Public Offering (IPO)
  • Initial Public Offering (IPO) refers to the process when a private or unlisted company sells its shares to the public for the very first time.
  • This process transforms the company from being privately owned to a public company.
    • This is why an IPO is also referred to as “going public”.
  • It is generally used by new and medium-sized firms that are looking for funds to grow and expand their business.
  • After IPO, the company’s shares are traded in an open market.
    • Those shares can be further sold by investors through secondary market trading.
Follow on Public Offering (FPO)
  • Follow on Public Offering (FPO) refers to the process when a company, that has already issued shares and is listed on a stock exchange, issues shares again to raise additional fund.
  • Public companies have to sell at least 25% of their shares to the public to be traded on a stock exchange. Usually, it is this requirement that makes companies go for FPOs.

Offer For Sale

  • Under this method, securities are not issued directly to the public but are offered for sale through intermediaries like issuing houses or stock brokers.
  • In this case, a company sells securities enbloc at an agreed price to brokers who, in turn, resell them to the investing public.

Bonus Issue or Scrip Issue or Capitalization Issue

  • It refers to offer of share to the existing shareholders against their distributable profit.
  • Thus, under this, shareholders’ share in profit is converted as shares.

Rights Issue

  • Rights Issue is an invitation to existing shareholders to purchase additional new shares in the company.
  • This type of issue gives existing shareholders rights to purchase new shares at a discount to the market price on a stated future date.
    • That’s why it is called Rights Issue.

Private Placement

When an issuer makes an issue of securities to a limited group of pre-selected investors, and which is neither a rights issue nor a public issue, it is called a private placement.

Private placement can be of 2 types:

Preferential Allotment

When a listed issuer issues shares or convertible securities to a select group of persons, it is called a Preferential Allotment.

Qualified Institutional Placement (QIP)

When a listed issuer issues shares or convertible securities to a select group of Qualified Institutional Buyers (QIBs), it is called a Qualified Institutional Placement (QIP).

Declared Price Issue

Its a method of pricing new issues wherein the issuer offers securities at a pre-fixed price.

Book Building Issue

Its is another method of pricing new issues wherein the price is not announced beforehand. Rather, the issuer, first, offers the shares and gets application from public and then based on the demand fixes the price.

Authorized Capital

It is the maximum amount authorized by Memorandum of Association of a company that can be raised by the company. The issuer can issue securities upto worth this amount only.

Issued Capital

It is the actual amount issued by the issuer. It may be equal to or lesser than the Authorized Capital.

Subscribed Capital

After the company issues shares, the public starts subscribing to those shares. The subscription can be oversubscribed (demand of shares more than the issued number of shares) or undersubscribed (demand of shares less than the issued number of shares). The actual amount subscribed is called Subscribed Capital.

Merchant Bankers

A “merchant banker” means any person who is engaged in the business of issue management either by making arrangements regarding selling, buying or subscribing to securities or acting as manager, consultant, adviser or rendering corporate advisory service in relation to such issue management.

Underwriting

Underwriting means an agreement with or without conditions to subscribe to the securities of a body corporate when the existing shareholders of such body corporate or the public do not subscribe to the securities offered to them.

Underwriter

The financial intermediary which agrees to purchase the undersubscribed portion of issued capital is called Underwriter.

Called Up Capital

The company usually collects the subscribed capital in installments. The portion of money demanded from subscriber is known as Called Up Capital.

Paid Up Capital

The amount actually paid by subscribers, when the money is demanded by the issuer, is known as Paid Up Capital.

Reserve Capital

Usually, the issuer does not demand the whole amount from the subscriber. A small portion of money is left un-demanded, which is called Reserve Capital.

Based on the type of trading, the secondary market has 2 components:

Over-The-Counter (OTC) Market

  • Over-The-Counter Markets or OTC Markets are essentially informal markets for trading securities.
  • It is a decentralized marketplace where securities are traded directly between two parties, bypassing a central exchange.
  • OTC markets are generally subject to less stringent regulations than exchanges.

Stock Exchange Market

It refers to markets for trading of securities through a centralized exchange, usually called Stock Exchange.

Listed Securities

Listed Securities refer to those securities that are accepted to be traded in stock exchanges.

Cash Trading

Its a type of trading in the Secondary Market wherein the sale and purchase of securities takes place at the prevailing price on the day of trading.

Forward Trading

Its another type of trading in the Secondary Market wherein both buyer and seller agree to buy and sell respectively at a future date at a pre-agreed price, irrespective of the price that prevails on the day of trade.

Third Market

  • Third Market refers to the trading of exchange-listed securities in the over-the-counter (OTC) market.
  • It allows institutional investors to trade blocks of securities directly, rather than through an exchange, providing liquidity and anonymity to buyers.

Fourth Market

Fourth Market refers to institution-to-institution trading directly, without using the service of broker-dealers, thus avoiding both commissions, and the bid–ask spread.

  • A Stock Exchange is a regulated marketplace where investors can buy and sell shares of publicly traded companies.
    • It acts as a central hub for facilitating stock trading in a secure and efficient manner.
  • In India, a Stock Exchange can operate only if it is recognized by the Government under the Securities Contracts (Regulation) Act, 1956.

Bombay Stock Exchange (BSE)

  • The Bombay Stock Exchange (BSE) is India’s largest and earliest securities market.
  • It is also Asia’s first stock exchange.
  • BSE On-Line Trading (BOLT) is a screen-based automated trading platform of BSE.
  • The BSE also offers depository services through one of its arms called the Central Depository Services Limited (CDSL)

National Stock Exchange of India Ltd. (NSE)

  • The National Stock Exchange of India Ltd. (NSE) is India’s largest financial market.
  • It ranks fourth in the world by equity trading volume.
  • NSE is the first exchange in India to provide modern, fully automated electronic trading.
  • A Stock Market Index is a statistical measure that reflects the overall performance of a specific segment of the stock market, or the entire market itself.
  • Each index is composed of a weighted values of specific group of stocks chosen based on certain criteria such as Market Capitalization, Representation of various sectors, etc.
  • From each sector, top companies are selected on the basis of total value of all shares that are traded in the stock exchange.
    • These companies are called Blue Chip Companies.
  • It acts as an indicator of rise or fall in the prices of shares or other securities.
  • Investors use Stock Market Indices as a benchmark to track market movements and compare the performance of their investments.

BSE Sensex or Sensitive Index

It is an index of BSE, which measures the price movement of top 30 companies’ shares.

Nifty or National Index for Fifty

It is an index of NSE, which measures price movement of top 50 companies.

Nifty Junior

It is an index of NSE, which measures the price movement of the next top 50 companies.

The Capital Market, as the major channel for mobilization of funds, plays very crucial role in an economy. Some of the its major roles and importance can be seen as follows:

  • Mobilization of Savings: It mobilizes idle savings or funds from people for further investments in the productive channels of an economy.
  • Capital Formation: Through mobilization of ideal resources it helps in formation of capital.
  • Investment Avenues: It enables to raise resources for longer periods of time. Thus it provides an investment avenue for people who wish to park their resources for a long period of time and earn reasonable return.
  • Economic Growth and Development: As it makes funds available for long period of time, the financial requirements of business houses are met by the capital market. This, in turn, helps them grow.
  • Optimal Allocation of Fund: By enabling price discovery as per the demand and supply, it helps in optimal allocation of financial resources.
  • Service Provision: As an important financial set up, capital market provides various types of services. It includes long term and medium term liquidity to industry, underwriting services, consultancy services, export finance, investor education by widening ownership base.
  • Barometer of Economic Health: The performance of the Secondary Market acts as the barometer of economic health. The investors use the level of stock exchange indices as a benchmark to track market movements and compare the performance of their investments.
  • Securities Contracts (Regulations) Act, 1956: It gives Central Government regulatory jurisdiction over
    • stock exchanges – through a process of recognition and continued supervision.
    • contracts in securities, and
    • listing of securities on stock exchanges.
  • Companies Act, 2013: It regulates incorporation of a company, lays down responsibilities of a company, directors, dissolution of a company.
    • The Companies Act is mainly administered by the Union Ministry of Corporate Affairs.
  • SEBI Act, 1992: It has established the Securities and Exchange Board of India (SEBI) as the primary regulator of securities markets in India.
  • Depositories Act, 1996: It provides a legal framework for establishment of depositories to facilitates holding of securities in physical/dematerialised form and to effect the transfer of securities through book entry only.
  • RBI’s Provisions for NBFCs: Of late, the RBI has proposed a significant shift in its regulatory approach towards the NBFCs.

The Capital Market serves as a vital channel for mobilizing savings into investments, and hence driving economic growth and prosperity. As India aims to grow faster in the time times to come, the role of the Capital Market is going to become even more important. Efforts should be taken to ensure its efficient functioning by focusing on transparency, fairness, and regulatory oversight to maintain investor confidence and market integrity.

  • Qualified Institutional Buyers (QIBs) are those institutional investors who are generally perceived to possess expertise and the financial muscle to evaluate and invest in the capital markets.
  • Some prominent examples of QIBs are – Insurance companies, provident funds, pension funds.
  • A commodity exchange is an exchange where various commodities, derivative products, agricultural products and other raw materials are traded.
  • The commodity exchanges in India includes – National Spot Exchange Limited (NSEL), Indian Commodity Exchange Limited (ICEX), Multi Commodity Exchange (MCX), etc.
  • Commodity Exchanges in India are regulated by the Securities and Exchange Board of India (SEBI).
    • Earlier, they were regulated by the Forward Markets Commission (FMC), which got merged with the SEBI on September 28, 2015.

What is Indian Capital Market?

Indian Capital Market is a component of Indian Financial Market which provides a market for borrowing and lending of medium and long-term funds, above 1 year.

Who controls the Capital Market in India?

The Indian capital market isn’t controlled by a single entity, but rather overseen by a number of regulatory bodies, including Securities and Exchange Board of India (SEBI), Union Ministry of Corporate Affairs, Reserve Bank of India (RBI), etc.

Who regulates the Capital Market in India?

There are several bodies involved in regulation of Capital Market in India. They include – Securities and Exchange Board of India (SEBI), Union Ministry of Corporate Affairs, Reserve Bank of India (RBI), etc.

Why do we need Capital Market?

The Capital Market is the major channel for mobilization of funds from investors to borrowers.

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