Capital Market

A capital market is a sector of the financial market that deals with the buying and selling of long-term financial instruments such as stocks, bonds, and other securities. It provides a platform for businesses, governments, and other entities to raise long-term funds by issuing equity (stocks) and debt (bonds) to investors. Capital markets are vital for economic growth as they provide businesses with access to capital for expansion, innovation, and development.

Types of Capital Markets

1. Primary Market:
   • The primary market is where new securities are issued for the first time. It is the market in which companies, governments, or other entities sell newly issued shares (equity) or bonds (debt) to investors.
   • Instruments Traded: Newly issued stocks, bonds, and other securities.
   • Process:
     • Companies raise capital by issuing stocks (equity) through Initial Public Offerings (IPOs) or bonds (debt) through public offerings or private placements.
     • The proceeds from these sales go directly to the issuer.
   • Role: Facilitates capital formation and allows issuers to raise funds for business expansion, infrastructure development, or governmental projects.
2. Secondary Market:
   • The secondary market is where previously issued securities are bought and sold between investors. In this market, investors trade securities among themselves, without involving the issuing company.
   • Instruments Traded: Stocks, bonds, and other previously issued financial instruments.
   • Examples: Stock exchanges like the New York Stock Exchange (NYSE), NASDAQ, London Stock Exchange (LSE), and Bombay Stock Exchange (BSE).
   • Role: Provides liquidity to investors, allowing them to buy or sell securities at prevailing market prices. It also helps in determining the market value of securities based on supply and demand.

Key Instruments Traded in the Capital Market

1. Equity (Stocks):
   • Definition: Shares of ownership in a company. When investors buy stock, they own a portion of the company and have a claim on its assets and earnings.
   • Types:
     • Common Stock: Represents ownership with voting rights but no fixed dividends.
     • Preferred Stock: Represents ownership with a fixed dividend but usually no voting rights.
   • Role: Stocks allow companies to raise capital for business expansion, while investors get the opportunity to earn returns through dividends and capital appreciation.
2. Bonds (Debt Securities):
   • Definition: Debt instruments issued by companies, governments, or other entities to raise capital. When investors buy bonds, they are lending money to the issuer in exchange for periodic interest payments and the repayment of the principal at maturity.
   • Types:
     • Government Bonds: Issued by national governments to finance public spending.
     • Corporate Bonds: Issued by companies to raise funds for business operations, expansion, or projects.
     • Municipal Bonds: Issued by local government bodies to finance infrastructure projects.
   • Role: Bonds are essential for raising capital without giving up ownership (as with stocks). They provide investors with a relatively stable income through interest payments.
3. Hybrid Instruments:
   • These are securities that combine features of both debt and equity. An example is convertible bonds, which can be converted into a predetermined number of shares in the company at a future date.

Participants in the Capital Market

1. Issuers:
   • These are the entities that raise funds by issuing securities. They include corporations (for issuing stocks and bonds), governments (for issuing government bonds), and other institutions.
   • Purpose: To raise capital for business activities, government projects, or infrastructure development.
2. Investors:
   • Investors are individuals, institutional investors (e.g., mutual funds, pension funds, insurance companies), or other financial entities that purchase securities in the capital market.
   • Purpose: To generate returns on investments through capital appreciation (increase in stock prices) or income (through interest payments on bonds).
3. Intermediaries:
   • These include investment banks, stock brokers, dealers, and financial advisors who facilitate the buying and selling of securities.
   • Role: They help issuers raise capital, advise on pricing, market the securities, and execute buy/sell orders for investors.
4. Regulators:
   • Regulatory bodies oversee the functioning of the capital markets to ensure transparency, fairness, and protection of investors. Examples include the Securities and Exchange Commission (SEC) in the U.S. and the Securities and Exchange Board of India (SEBI).
   • Role: They establish and enforce rules to ensure that securities markets operate efficiently and protect investors from fraud and manipulation.

Functions of the Capital Market

1. Capital Formation:
   • Capital markets allow companies and governments to raise funds by issuing stocks and bonds. These funds are then used for business expansion, infrastructure development, and other productive economic activities.
2. Liquidity:
   • The secondary market provides liquidity by allowing investors to buy and sell securities easily. This encourages investment in the primary market as investors know they can trade securities quickly if needed.
3. Price Discovery:
   • The interaction between buyers and sellers in the market helps determine the fair price of securities. Stock prices, bond yields, and other financial instrument prices are determined through supply and demand forces.
4. Risk Diversification:
   • Investors can diversify their portfolios by investing in different types of securities (stocks, bonds, hybrid instruments) across various sectors and geographies. This helps manage risk and reduce exposure to any single investment.
5. Economic Growth:
   • By providing a platform for raising capital, capital markets play a crucial role in driving economic growth. Investments made through the capital markets lead to the creation of new businesses, technological advancements, and job creation.