The capital market is an important part of the financial system where long-term funds are raised and traded. It acts as a bridge between investors who have surplus funds and companies or governments that require money for long-term investment and development purposes. The capital market helps in mobilizing savings from individuals and institutions and channeling them into productive sectors of the economy.
The instruments traded in the capital market generally have a maturity period of more than one year. These instruments include shares, debentures, bonds, mutual funds, exchange traded funds, and other long-term securities. The capital market plays a vital role in economic development by encouraging savings, promoting investment, generating employment, and facilitating industrial and infrastructural growth.
A proper understanding of capital market terminology and concepts is essential because these topics are widely used in banking, finance, investment analysis, business studies, and competitive examinations.
Features of Capital Market
The capital market possesses several important features that distinguish it from the money market. It deals mainly with medium-term and long-term funds required for business expansion and economic development. The market provides investment opportunities to investors and long-term financing to companies and governments.
The capital market is market-oriented in nature, meaning that prices of securities are determined by demand and supply forces. It also provides liquidity to investors through organized stock exchanges where securities can be bought and sold easily.
Another important feature of the capital market is risk and return. Investments in capital market instruments generally involve higher risk compared to money market instruments, but they also provide the possibility of higher returns over the long term.
Objectives of Capital Market
The main objective of the capital market is to facilitate the transfer of long-term funds from savers to borrowers. It helps industries, businesses, and governments obtain capital for development projects and expansion activities.
The capital market also aims to promote savings and investment habits among people. It provides liquidity and marketability to securities, encourages capital formation, ensures efficient allocation of financial resources, and contributes to economic growth and financial stability.
Components of Capital Market
The capital market consists of two major segments: the primary market and the secondary market.
The primary market deals with the issue of new securities, while the secondary market deals with the trading of existing securities. Both segments are interconnected and together ensure smooth functioning of the financial system.
The capital market also includes financial institutions, stock exchanges, brokers, merchant bankers, depositories, mutual funds, and regulatory authorities.
Primary Market
The primary market is the segment of the capital market where new securities are issued for the first time. When companies, governments, or institutions raise funds directly from investors by issuing shares, debentures, or bonds, the transaction takes place in the primary market.
The money raised through the primary market goes directly to the issuing company or institution. Companies use these funds for business expansion, modernization, diversification, repayment of loans, or financing new projects.
Investors in the primary market purchase securities at the issue price determined by the company. Since the securities are being sold for the first time, this market is also known as the “new issue market.”
Methods of Issuing Securities in Primary Market
Companies can issue securities in different ways in the primary market. One common method is the public issue, where securities are offered to the general public. Another method is the rights issue, where existing shareholders are given the right to purchase additional shares.
Private placement is another method in which securities are sold directly to selected investors or institutions. Companies may also use preferential allotment to issue shares to specific investors at predetermined prices.
Initial Public Offering (IPO)
An Initial Public Offering, commonly known as an IPO, is the process through which a private company offers its shares to the public for the first time. Through an IPO, a private company becomes a publicly listed company, and its shares are traded on a stock exchange.
An IPO helps companies raise equity capital from public investors. It also provides investors with an opportunity to become shareholders and part owners of the company.
Companies launch IPOs for various reasons such as expanding business operations, reducing debt, increasing market visibility, or raising funds for future projects. After the IPO process is completed, the company’s shares are listed on stock exchanges such as the Bombay Stock Exchange (BSE) or the National Stock Exchange (NSE).
Follow-on Public Offer (FPO)
A Follow-on Public Offer (FPO) refers to the issue of additional shares by a company that is already listed on a stock exchange. Unlike an IPO, an FPO is not the company’s first public issue.
Companies use FPOs to raise additional funds for business expansion, debt reduction, acquisitions, modernization, or other corporate purposes. Since the company is already publicly listed, investors are usually familiar with its financial performance and market reputation.
Secondary Market
The secondary market is the market where already issued securities are bought and sold among investors. In this market, transactions take place between investors without direct involvement of the issuing company.
Stock exchanges such as the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) provide organized platforms for secondary market trading.
The secondary market provides liquidity to investors because securities can be easily bought and sold. It also helps in price discovery, where market prices are determined by demand and supply forces. A strong secondary market increases investor confidence and promotes investment activity in the economy.
Difference Between Primary Market and Secondary Market
The primary market deals with the issue of new securities, whereas the secondary market deals with trading of existing securities. In the primary market, funds are directly received by the issuing company, while in the secondary market, funds are exchanged between investors.
The primary market helps in capital formation, whereas the secondary market provides liquidity and marketability to securities.
Stock Exchange
A stock exchange is an organized marketplace where securities such as shares, bonds, debentures, and derivatives are traded. Stock exchanges provide a regulated and transparent environment for buying and selling securities.
The two major stock exchanges in India are the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). These exchanges ensure fair trading practices, investor protection, proper settlement of transactions, and transparency in market operations.
Stock exchanges play an important role in capital formation, economic development, and efficient allocation of financial resources.
Functions of Stock Exchange
Stock exchanges perform several important functions in the economy. They provide liquidity to investors by enabling easy buying and selling of securities. They help in price discovery through continuous trading activities and ensure transparency in transactions.
Stock exchanges also protect investor interests by regulating trading practices and monitoring market participants. They facilitate capital formation by helping companies raise funds from the public.
Participants in Capital Market
Several participants operate in the capital market. These include investors, companies, stock brokers, merchant bankers, underwriters, mutual funds, institutional investors, depositories, custodians, and regulatory authorities.
Retail investors invest their personal savings in securities, while institutional investors such as insurance companies, banks, pension funds, and mutual funds invest large amounts in financial markets.
Merchant bankers help companies manage public issues, while brokers facilitate trading in securities.
Equity Shares
Equity shares represent the ownership capital of a company. Individuals who purchase equity shares become shareholders and partial owners of the company. Equity shareholders enjoy voting rights and can participate in important corporate decisions.
Equity shareholders receive dividends depending upon the profitability of the company. However, dividend payment is not guaranteed because it depends on the company’s earnings and management decisions.
Equity shares carry higher risk compared to fixed-income securities because their market prices fluctuate according to market conditions, company performance, and investor sentiment. However, they also offer the possibility of higher returns and capital appreciation over time.
Preference Shares
Preference shares are a type of share capital that provides preferential rights to shareholders over equity shareholders. Preference shareholders receive dividends before equity shareholders and also get priority in repayment of capital during liquidation of the company.
Preference shares generally carry a fixed rate of dividend. However, preference shareholders usually do not enjoy voting rights except under special circumstances.
Preference shares are considered less risky than equity shares because of their fixed dividend feature and preferential treatment.
Debentures
Debentures are long-term debt instruments issued by companies to raise borrowed funds from investors. Debenture holders are creditors of the company and not owners.
Companies pay fixed interest on debentures at predetermined intervals regardless of profits. Debentures may be secured or unsecured and may also be convertible or non-convertible.
Compared to equity shares, debentures involve lower risk because interest payments are fixed and debenture holders get priority over shareholders during liquidation.
Bonds
A bond is a fixed-income financial instrument issued by governments, public sector undertakings, financial institutions, or companies to raise long-term funds. Bonds promise regular interest payments and repayment of principal amount on maturity.
Government bonds are generally considered low-risk investments because they are backed by the government. Corporate bonds may offer higher returns but involve comparatively higher risk.
Bonds are widely used for financing infrastructure projects, industrial expansion, and public expenditure.
Mutual Funds
A mutual fund is an investment vehicle that pools money from multiple investors and invests it in diversified securities such as shares, bonds, and money market instruments.
Professional fund managers manage mutual funds on behalf of investors. Mutual funds help small investors participate in the capital market with reduced risk through diversification.
Derivatives
Derivatives are financial instruments whose value is derived from underlying assets such as shares, commodities, currencies, or indices. Common derivative instruments include futures and options.
Derivatives are mainly used for hedging risk, speculation, and arbitrage in financial markets.
Face Value
Face value refers to the nominal or original value of a security as mentioned on the share or bond certificate. In India, the face value of equity shares is generally ₹1, ₹2, ₹5, or ₹10.
Face value is important for accounting purposes and is also used in calculating dividends, interest payments, and stock splits.
Market Price
The market price is the price at which a security is currently traded in the secondary market. Unlike face value, market price constantly changes according to demand and supply conditions in the market.
Factors such as company performance, investor expectations, economic conditions, political developments, and market sentiment influence the market price of securities.
Dividend
A dividend is a portion of a company’s profits distributed among shareholders as a reward for their investment. Dividends are usually declared by the company’s board of directors.
For equity shareholders, dividend payments are not fixed and depend on the profitability and financial position of the company. Preference shareholders generally receive fixed dividends before equity shareholders.
Capital Gain
Capital gain refers to the profit earned when a security is sold at a price higher than its purchase price. Capital gains may be short-term or long-term depending on the holding period of the investment.
Capital gains are one of the major objectives of investment in the capital market.
Bonus Shares
Bonus shares are additional shares issued by a company to its existing shareholders free of cost in proportion to their existing holdings. These shares are issued out of accumulated reserves and surplus profits of the company.
Bonus shares increase the number of shares held by investors without requiring additional investment.
Rights Issue
A rights issue is an offer made by a company to its existing shareholders to purchase additional shares at a concessional price within a specified period.
Rights issues help companies raise additional capital while giving existing shareholders an opportunity to maintain their ownership proportion in the company.
Bull Market
A bull market refers to a market condition in which the prices of securities are continuously rising or are expected to rise. It reflects strong investor confidence, positive market sentiment, economic growth, and optimistic business conditions.
Bear Market
A bear market is a market situation where the prices of securities decline continuously over a prolonged period. It reflects pessimism, weak investor confidence, economic slowdown, and negative market sentiment.
Market Capitalisation
Market capitalisation refers to the total market value of a company’s outstanding shares. It is calculated by multiplying the current market price per share by the total number of outstanding shares.
Based on market capitalisation, companies are classified as large-cap, mid-cap, or small-cap companies.
Demat Account
A Demat account is an electronic account used to hold securities in digital form. It eliminates the need for physical share certificates and makes trading safer, faster, and more convenient.
In India, depositories such as NSDL and CDSL provide dematerialization services.
Depository and Depository Participants
A depository is an institution that holds securities in electronic form. Depository Participants (DPs) act as intermediaries between investors and depositories.
Depositories simplify transfer, settlement, and safekeeping of securities.
Sensex and Nifty
Sensex is the benchmark stock market index of the Bombay Stock Exchange (BSE), while Nifty is the benchmark index of the National Stock Exchange (NSE).
These indices indicate the overall performance and direction of the stock market and are widely used as economic indicators.
Securities and Exchange Board of India (SEBI)
The Securities and Exchange Board of India (SEBI) is the regulatory authority for the securities market in India. SEBI was established to protect investors’ interests, regulate market intermediaries, and promote the development of the capital market.
SEBI ensures transparency, fair trading practices, and proper functioning of stock exchanges and financial institutions. It regulates activities related to IPOs, mutual funds, brokers, merchant bankers, and other market participants.
SEBI plays a central role in maintaining investor confidence and ensuring orderly growth of the Indian capital market.
Importance of Capital Market
The capital market plays a crucial role in the economic development of a country. It helps in mobilizing long-term savings and directing them toward productive investments. It provides companies and governments with access to long-term funds required for infrastructure development, industrial expansion, and economic growth.
The capital market also promotes investment opportunities for individuals, encourages entrepreneurship, creates employment, and contributes to wealth creation.
An efficient capital market strengthens the financial system and supports overall economic stability.
Conclusion
The capital market is an essential component of the financial system that facilitates the raising and trading of long-term funds. It includes various institutions, instruments, and participants that work together to support investment and economic development.
A clear understanding of capital market concepts and terminology helps students, investors, and professionals analyse financial markets effectively and make informed investment decisions. Knowledge of terms such as IPO, FPO, equity shares, debentures, bonds, dividends, derivatives, market capitalisation, and SEBI is extremely important for academic studies, competitive examinations, and practical understanding of financial markets.