Capital Market – Meaning, Classification and Instruments

Stuti Mishra

5 months ago

The capital market plays a pivotal role in the financial system by enabling the flow of long-term funds between investors and companies. It serves as a platform for businesses to raise capital for expansion, while providing investors with opportunities to grow their wealth. As a key topic for UGC NET Commerce students, understanding the capital market and its financial instruments is crucial. By learning about the structure, types, and functioning of capital markets, students can better comprehend the role they play in economic development and investment strategies.

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Understanding Capital Market

Capital markets are platforms where buyers and sellers trade financial securities like stocks, bonds, etc.
These markets typically involve long-term investments, catering to the funding needs of businesses and government.
They facilitate the flow of funds by channeling savings from individuals or institutions to productive uses through financial instruments.
Broadly, the market is split into securities and non-securities markets, catering to various forms of investment and financial instruments.

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Classification of Capital Market

The capital market is broadly classified into two parts:

Primary Market
Secondary Market

Primary Capital Market

What is Primary Capital Market?

It deals with the issuance of new securities, such as stocks and bonds, by companies to raise capital.
In this market, a company gets listed on a stock exchange and offers its securities for sale for the first time, known as an Initial Public Offering (IPO).
The primary market enables a company to raise funds directly from investors.

Primary Market Facilitators

Several key players help facilitate transactions in the primary market:

Underwriter: A professional who guarantees the subscription of securities if public demand falls short.
Merchant Banker: A financial advisor who helps manage the issuance process and ensures compliance with regulations.
Banker to the Issue: A scheduled bank responsible for handling various activities related to the issuance.
Registrar to an Issue (RTI): An entity responsible for managing applications and funds from investors, ensuring accurate recordkeeping.

Secondary Capital Market

What is Secondary Capital Market?

The Secondary Capital Market is where existing securities are bought and sold among investors.
Once securities are issued in the primary market, they can be traded in the secondary market.
It provides liquidity to investors, allowing them to buy or sell securities based on market prices.

Types of Secondary Capital Market

Stock Exchange: A regulated platform where securities are bought and sold, such as NSE and BSE.
Over-the-Counter (OTC) Market:
- Informal trading of securities not listed on formal exchanges.
- This market involves direct transactions between buyers and sellers, often for smaller companies that do not meet the listing requirements.
Exchange-Traded Market: It is a market where transactions are routed through a central exchange.

Secondary Market Facilitators

Several intermediaries play key roles in the secondary market:

Custodian: Ensures the safekeeping of securities for clients and provides related services.
Stockbroker: A registered individual or firm that buys and sells securities on behalf of investors.
Sub-Broker: A person who acts on behalf of a stockbroker, assisting investors with their transactions.
Portfolio Manager: A professional who manages a client’s portfolio of securities and investments, providing personalized advice and strategies.

Instruments of the Capital Market

Here are the key instruments of the capital market:

Equity Shares: Represent ownership in a company and offer dividends and voting rights. These are high-risk, high-return instruments typically traded in the secondary market.
Preference Shares: Offer fixed dividends and have priority over equity shares in case of liquidation, but they do not carry voting rights.
Bonds: Debt instruments issued by companies or governments, offering fixed or variable interest. Investors lend money in exchange for periodic interest payments and the return of the principal at maturity.
Debentures: Unsecured debt instruments issued by companies, similar to bonds but without any collateral backing. They typically offer higher returns due to the higher risk involved.
Government Securities: These are bonds issued by the government to raise capital, known for being low-risk investments.
Commercial Papers: Short-term debt instruments issued by corporations for financing their immediate working capital needs.
Certificates of Deposit (CDs): Issued by banks to raise short-term funds, CDs offer a fixed interest rate for a specified period.
Mutual Funds: Pooled investment vehicles where investors’ funds are collected and managed by professionals to invest in a diversified portfolio of stocks, bonds, or other securities.
Exchange-Traded Funds (ETFs): Similar to mutual funds, but traded on stock exchanges, offering flexibility and lower management fees.
Securitized Instruments: Financial assets like loans or mortgages are pooled and sold as securities to investors, providing liquidity to the originating institutions.

Capital Market Conclusion

The capital market is essential for facilitating long-term investments and economic growth. It connects investors with companies, offering opportunities to buy and sell securities like equity shares, debentures, and bonds. The market is divided into the primary market, where new securities are issued, and the secondary market, where these securities are traded. By providing liquidity and capital, the capital market helps businesses expand and investors manage risk. Understanding these functions and instruments is crucial for UGC NET Commerce students aiming to master financial market concepts.