CAPITAL MARKET A PART OF FINANCIAL MARKET:

Financial M arkets:
Efficient transfer of resources from those having idle resources to others who have a
pressing need for them is achieved through financial markets. Stated formally,
financial markets provide channels for allocation of savings to investment. These
provide a variety of assets to savers as well as various forms in which the investors
can raise funds and thereby decouple the acts of saving and investment. The savers
and investors are constrained not by their individual abilities, but by the economy's
ability, to invest and save respectively. The financial markets, thus, contribute to
economic development to the extent that the latter depends on the rates of savings
and investment.

A financial market is a broad term describing any marketplace where buyers and
sellers participate in the trade of assets such as equities, bonds, currencies and
derivatives. Financial markets are typically defined by having transparent pricing,
basic regulations on trading, costs and fees, and market forces determining the
prices of securities that trade.

Financial markets can be found in nearly every nation in the world. Some are very
small, w ith only a few participants, while others -like the New York Stock Exchange
(NYSE} and the forex markets- trade t rillions of dollars daily.

Investors have access to a large number of financial markets and exchanges

representing a vast array of financial products. Some of these markets have always
been open to private investors; others remained the exclusive domain of major
international banks and financial professionals until the very end of the twentieth
century.

The financial markets have two major components; the money market and the
capital market.
 . I:..<:•·.;L...·.·"· '. . - ,,,.-.... "
· Financial Market · I

I
I
Capital Market ' Money Market

Other forms of lending &

Securities Market
borrowing

New issues market

SecondarY markets

Money Market The money market refers to the market where borrowers and
lenders exchange short-term funds to solve the ir liquidity needs. Money market
instruments are generally f inancial claims that have low default risk, maturities under
one year and high marketability.

A capital market is a financial market in which long-term debt (over a year) or equity-
backed securities are bought and sold . Capital markets channel the wealth of savers
to those who can put it to long-term productive use.
MONEY MARKET vs. CAPITAL MARKET
The money market possesses different operational features as compa red to capital
market. Money market is distinguished from capital market on the basis of t he
maturity period, cred it instruments and the institutions:

1. Maturity Period: The money market deals in the lending and borrowing of
short-term finance varying for one year or less, while the capital market deals
in the lending and borrowing of long-term finance for more than one year.

2. Credit Instruments: The main credit instruments of the money market are call
money, treasury bills, commercial bills, commercial papers, and bills of
exchange. On the other hand, the main instruments used in the capital market
are stocks, shares, debentures, bonds, corporate deposits etc.

3. Institutions: Important institutions operating in the money market are centra l

banks, commercial banks, acceptance houses, non banking financial
institutions, bill brokers, etc. Important institutions of the capital market are
stock exchanges, commercial banks and no!'l ban king inst itutions, such as
insurance companies, mortgage banks, etc.

4. Purpose of loan: The money market meets the short-term credit needs of
business; it provides working capital to the industrialists. The capital market,
on the other hand, caters the long-term credit needs of the industrialists and
provides fixed capital to buy land, machinery, etc.

5. Risk and Liquidity: The degree of risk is small and that of liquidity is higher in
the money market as compared to the higher risk and lower liquidity in the
capital market.

6. Role of Central Bank: The central bank close ly and directly has impact on the
money market and its participants by framing its regulations and deciding
various rates of interests that has impact on the parameters of an economy,
while in case of capital market central bank has an indirect link through other
regulators like SEBI.

7. Market Regulation: In the money market, commercial banks are closely

regulated . In the capital market, the institutions are not much regulated.
WHAT ARE 'CAPITAL MARKETS':

"Capital Markets" refers to activities that gather funds from some entities and make
them available to other entities needing funds. The core function of such a market is
to improve the efficiency of transactions so that each individual entity doesn't nee.d
to do search and analysis, create legal agreements, and complete funds transfer.

A capital market is a financial market in which long-term debt (over a year) or equity-
backed securities are bought and sold. Capital markets channel the wealth of savers
to those who can put it to long-term productive use, such as compan ies or
governments making long-term investments. Financial regulators like the Ban k of
England (BoE) and the U.S. Securities and Exchange Commission (SEC) oversee capital
markets to protect investors against fraud, among other duties.

Modern capital markets are almost invariably hosted on computer-based electronic

trading systems; most can be accessed only by entities within the financial sector or
the treasury departments of governments and corporations, but some can be
accessed directly by the public. There are many thousands of such systems, most
serving only small parts of the overall capital markets. Entities hosting the systems
include stock exchanges, investment banks, and government departments.
Physically, the systems are hosted all over the world, though they tend to be
concentrated in financial centers like London, New York, and Hong Kong .

The capital markets are a source of financing for companies around the world . The
most famous of the capital markets are the stock market and bond market.
HOW IT WORKS (EXAMPLE) :

Companies utilize capital markets to raise money for projects by

issuing stock IPOs, bonds and short-term money market securities. Individual
investors wish to earn interest or dividends on their savings can meet companies
looking to raise funds by issuing securities.

To illustrate how a corporate bond moves through capital markets, suppose AB Co.
needs to raise Rs.lOOO. AB Co. offers a 10-year bond on the bond market with a par
value of Rs.lOOO. The bond is purchased by someone wishing to earn interest on t he
Rs.lOOO that they have available. AB Co. receives the Rs.lOOO in cash and the
investor receives a bond and the promise of repayment plus interest. Should
the bondholder later decide he no longer wants the bond, he can sell it to another
investor in the marketplace.

To illustrate using stocks, suppose AB Co. decided to raise more funds by issuing ten
new shares of stock for Rs.lOO per share. AB Co. offers these shares in the market
and someone purchases all ten for Rs.lOOO total. This time, the investor obtains
stock certificates giving him partial ownership of the company. AB Co. gets the
Rs.lOOO in funds they wanted to raise. As in the example above, should this investor
wish to no longer hold these stocks, he can sell them to another investor in the stock
market for the current market price. Should the company have extra cash, it could
buy the stock back as well .

WHY IT MATIERS:

Capital markets serve two purposes. Firstly, they bring together investors
holding capital and companies seeking capital through equity and debt instruments.
Secondly, and almost more importantly, they provide a seconda ry market where
holders of these securities can exchange them with one another at market prices.
Without the liquidity created by a secondary market, investors would be less inclined
to purchase equity and debt instruments for fear of being unable to unload them in
the future.
NEED FOR CAPITAL MARKET:

• Capital market plays an extremely important role in promoting and sustaining

the growth of an economy.
• It is an important and efficient conduit to channel and mobil ize funds to
enterprises, both private and government.
• It provides an effective source of investment in the economy.
• It plays a critical role in mobilizing savings for investment in productive assets,
with a view to enhancing a country's long-term growth prospects, and thus
acts as a major catalyst in transforming the economy into a more efficient,
innovative and competitive marketplace within the global arena.
• In addition to resource allocation, capital markets also provide a medium for
risk management by allowing the diversification of risk in the economy.
• A well-functioning capital market tends to improve information quality as it
plays a major role in encouraging the adoption of stronger corporate
governance principles, thus supporting a trading environment, which is
founded on integrity.
• Capital market has played a crucial role in supporting periods of technological
progress and economic development throughout history.
• Among other things, liquid markets make it possible to obtain financing for
capital-intensive projects w ith long gestation periods. Th is certainly held true
during the industrial revolution in the 18th century and continues t o apply
even as we move towards the so-called " New Economy".
• Capita l markets make it possible for companies to give shares to their
employees via ESOPs. - Capital markets provide a currency for acquisitions
via share swaps.
• Capital markets provide an excellent route for disinvestments to take place.
• Venture Capita l and Private Equity funds investing in unlisted companies get
an exit option when the company gets listed on the capital markets
• The existence of deep and broad capital market is absolute ly crucial in
spurring the growth our country.

An essential imperative for India has been to develop its capital market to provide
alternat ive sources of funding for companies and in doing so, achieve more effective
mobilization of investors' savings.
Capital market also provides a valuable source of external finance. For a long time,
the Indian market was considered too small to warrant much attention. However,
this view has changed rapidly as vast amounts of both international and domestic
investment have poured into our markets over the last decade. The Indian market is
no longer viewed as a static universe but as a constantly evolving one providing
attractive opportunities to the investing community.

Capital

Other
forms of
• Market
lending and
borrowing

SECURITIES MARKET:

The Securities Market, refers to the markets for those financial

instruments/claims/obligations that are commonly and readily transferable by sale.
The Securities Market has two inter-dependent and inseparable segments, the new
issues (primary) market and the stock (secondary) market.
TYPES OF MARKET

A capital market can be either a primary market or a secondary market.

In primary markets, new stock or bond issues are sold to investors, often via a
mechanism known as underwriting. The main entities seeking to raise long-term
funds on the primary capital markets are governments (which may be municipal,
local or national) and business enterprises (companies). Governments issue only
bonds, whereas companies often issue both equity and bonds. The main entities
purchasing the bonds or stock include pension funds, hedge funds, sovereign wealth
funds, and less commonly wealthy individuals and investment banks trading on their
own behalf.
In the secondary markets, existing securities are sold and bought among investors or
traders, usually on an exchange, over-the-counter, or elsewhere. The existence of
secondary markets increases the willingness of investors in primary markets, as they
know they are likely to be able to swiftly cash out their investments if the need
arises.
A second important division falls between the stock markets (for equity' securities,
also known as shares, where investors acquire ownership of companies) and
the bond markets (where investors become creditors) .

1. Primary market

The primary market is that part of the capital markets that deals with the issuance of
new securities. Companies, governments or public sector institutions can obtain
funding through the sale of a new stock or bond issue. This is typically done through
a syndicate of securities dealers. The process of selling new issues to investors is
called underwriting. In the case of a new stock issue, this sale is an initial public
offering (IPO). Dealers earn a commission that is built into the price of the security
offering, though it can be found in the prospectus.

The primary market provides the channel for sale of new securities, while the
secondary market deals in securities previously issued. The issuer of securities sells
the securities in the primary market to raise funds for investment and/or to
discharge some obligation. In other words, the market wherein resources are
mobilized by companies through issue of new securities is called the primary market.
These resources are required for new projects as well as for existing projects with a
view to expansion, modernization, diversification and up gradation. The Primary
Market (New Issues) is of great significance to the economy of a country. It is
through the primary market that funds flow for productive purposes from investors
to entrepreneurs. The latter use the funds for creating new products and rendering
services to customers in India and abroad. The strength of t he economy of a country
is gauged by the activities of the Stock Exchanges. The primary market creates and
offers the merchandise for the secondary market.
Features of primary markets are:

• This is the market for new long term equity capital. The primary market is the
market w here the securities are sold for the first time. Therefore it is also
called the new issue market (NIM).
• In a primary issue, the securities are issued by the company directly to
investors.
• The company receives the money and issues new security certificates to the
investors.
• Primary issues are used by companies for the purpose of setting up new
business or for expanding or modernizing the existing business.
• The primary market performs the crucial function of facilitating capital
formation in the economy.

The new issue market does not include certain other sources of new long term
external finance, such as loans from financial institutions. Borrowers in the new issue
market may be raising capital for converting private capital into public capital; this is
known as "going public."

• The financia l assets sold can only be redeemed by the original holder.

Methods of issuing securities in the primary market are:

• Initial public offering;

• Rights issue (for existing companies);
• Preferential issue.
• Initial public offering

An initial public stock offering (IPO) referred to simply as an "offering" or

"flotation," is when a company issues common stock or shares to the public for the
first time. They are often issued by smaller, younger companies seeking capital to
expand, but can also be done by large privately-owned companies looking to become
publicly traded .

In an IPO the issuer may obtain the assistance of an underwriting firm, which helps it
determine what type of security to issue (common or preferred), best offering price
and time to bring it to market.

An IPO can be a risky investment. For the individual investor, it is tough to predict
what the stock or shares will do on its initial day of trading and in the near future
since there is often little historical data with which to analyze the company. Also,
most IPOs are of companies going through a transitory growth period, and they are
therefore subject to additional uncertainty regarding their future value.
Rights issue:

Under a secondary market offering or seasoned equity offering of shares to raise

money, a company can opt for a rights issue to raise capital. The rights issue is a
special form of shelf offering or shelf registration. With the issued rights, existing
shareholders have the privilege to buy a specified number of new shares from the
firm at a specified price within a specified time. A rights issue is in contrast to an
initial public offering (primary market offering), where shares are issued to the
general public through market exchanges.

2. Secondary market:

The secondary market, also known as the aftermarket, is the financial market where
previously issued securities and financial instruments such as stock, bonds, options,
and futures are bought and sold. The term "secondary market" is also used to refer
to the market for any used goods or assets, or an alternative use for an existing
product or asset where the customer base is the second market (for example, corn
has been traditionally used primarily for food production and feedstock, but a
second- or third- market has developed for use in ethanol production). Another
commonly referred to usage of secondary market term is to refer to loans which are
sold by a mortgage bank to investors such as Fannie Mae and Fredd ie Mac.

With primary issuances of securities or financial instruments, or the primary market,

investors purchase these securities directly from issuers such as corporations issuing
shares in an IPO or private placement, or directly from the federal government in the
case of treasuries. After the initial issuance, investors can purchase from other
investors in the secondary market.

The secondary market for a variety of assets can vary from loans to stocks, from
fragmented to centralized, and from illiquid to very liquid. The major stock
exchanges are the most visible example of liquid secondary markets- in this case, for
stocks of publicly traded companies. Exchanges such as the Bombay Stock Exchange
(BSE), National Stock Exchange (NSE), New York Stock Exchange, NASDAQ and the
American Stock Exchange provide a centralized, liquid secondary market for the
investors who own stocks that trade on those exchanges. Most bonds and structured
products trade "over the counter," or by phoning the bond desk of one's broker-
dealer. loans sometimes trade online using a loan Exchange. For Commodity market
the exchange is Multi- Commodity Exchange of India (MCX).

The secondary market enables those who hold securities to adjust their holdings in
response to changes in their assessment of risk and return. They also sell securities
for cash to meet their liquidity needs. The price signals, which subsume all
information about the issuer and his business including, associated risk, generated in
the secondary market, help the primary market in allocation of funds. Secondary
market essentially comprises of stock exchanges which provide platform for
purchase and sale of securities by investors. The trading platform of stock exchanges
is accessible only through brokers and trading of securities is confined only to stock
exchanges. The stock market or secondary market ensures free marketability,
negotiability and price discharge. For these reasons the stock market is referred to as
the nerve centre of the capital market, reflecting the economic trend as well as the
hopes, aspirations and apprehensions of the investors. This secondary market has
further two components,

1. First, the spot market where securities are traded for immediate delivery and
payment,
2. The other is futures market where the securities are traded for future delivery
and payment.
OPTIONS MARKET:

Another variant is the options market where securities are traded for conditional
future delivery. Generally, two types of options are traded in the options market. A
put option permits the owner to sell a security to the writer of the option at a pre-
determined price before a certain date, while a call option permits the buyer to
pu rchase a security from the writer of the option at a particular price before a certain
date .

Options are contracts that grant the right, but not the obligation to buy or sell an
und erlying asset at a set price on or before a certain date. The right to buy is called a
call option and the right to sell is a put option.

Has the right to Has e right to

Buye buy stock at a
certain price.
sell stock at a
certain price.
Ha$ the obligation Has the obligation

Seller to sell stock at a

certain pric:e.
to buy stock at a
certain price.
FUNCTIONS OF CAPITAL MARKET
• Mobilization of savings to finance long term investments.

• Facilitates trading of securities.

• Minimization oftransaction and information cost.

• Encourage wide range of ownership of productive assets.

• Quick valuation of financial instruments like shares and debentures.

• Facilitates transaction settlement, as per the definite time schedules.

• Offering insurance against market or price risk, through derivative trading.

• Improvement in the effectiveness of cap.i tal allocation, with the help of

competitive price mechanism.

Capital market is a measure of inherent strength of the economy. It is one of the best
source of finance, for the companies, and offers a spectrum of investment avenues
to the investors, which in turn encourages capital creation in the economy.

OBJECTIVES OF CAPITAL MARKET:

The major objectives of capital market are:

- To mobilize resources for investments.

-To facilitate buying and selling of securities.

-To facilitate the process of efficient price discovery.

CAPITAL MARKET INSTRUMENTS:

Financial Instruments that are used for raising capital resources in the capital market
are known as capital market instruments. The capital market instruments are usually
used by the Government, Corporations and Companies.

The instruments used by the corporate sector to raise funds are selected on the basis
of

(i) Investor preference for a given instrument,

(ii) The regulatory framework, which regulate the issue of security.

Factors effecting the preferences for choosing any instruments :

For issuers For investor

Cost Return
Post Tax Cost of Capital Tax on return received
Servicing Yield
Debt-equity ratio and debt service Risk reward ratio
capabilities
Ceding the control in case of equity Gaining the control in case of equity
Company law, SEBI Regulations etc Marketable and liquidity
CLASSIFICATION OF INSTRUMENTS

Hybrid Inst ruments Hybrid instruments are those which are created by combining
the features of equity with bond, preference and equity etc. Examples of Hybrid
instruments are: Convertible preference shares, Cumulative convertible preference
shares, convertible debentures, non convertible debentures w ith equity warrants,
partly convertible debentures, partly convertible debentures w ith Khokha (buy-back
arrangement), Optionally convertible debenture, warrants convertible into
debentures or shares, secured premium notes with warrants etc.

Pure Instruments Equity shares, preference shares and debentures/ bonds which
were issued with their basic characteristics in tact without mixing features of other
classes of instruments are called Pure instruments.

Derivatives Instruments Derivatives are contracts which derive their values from the
value of one or more of other assets (known as underlying assets). The derivative
itself is merely a contract between two or more parties. Its value is determined by
fluctuations in the underlying asset. The most common underlying assets include
stocks, bonds, commodities, currencies, interest rates and market indexes. Some of
the most commo nly traded derivatives are futures, forward, options and swaps.

--
'1ns fr ti ments
4

···~ '!Hybrid ~
ROLE OF CAPITAL MARKET INTERMEDIARIES

The role of intermediaries makes the market vibrant, and to function smoothly and
continuously. Intermediaries possess professional expertise and play a promotional
role in organizing a perfect match between the supply and demand for capital in the
market. All those, institutions or individuals, who help to bring the savers and
seekers of capital and enable a regular flow of funds from supply to demand points
are intermediaries. All intermediaries are service providers and are an integral part of
the Securities Market. These market intermediaries provide different types of
financial services to the investors. They are constant ly operating in the financial
market. It is in their (market intermediaries) own interest t o behave rationally,
maintain integrity and to protect and maintain reputation, otherwise the investors
wo uld not be trusting them next time. In principle, these intermediaries bring
efficiency to corporate fund raising by developing expertise in pricing new issues and
marketing them to the investors.

Capital Market Intermediaries

Primary Markets Secondary Market
1. Merchant Banker/Lead Manager 1. Stock-Broker
2. Registrars abd Sha re Transfer 2. Sub-Broker
Agents 3. Portfolio Managers
3. Underwriters 4. Custodians
4 . Bankers to Issue 5. Share Transfer Agents
5. Debenture Trustees

The f ollowing market intermediaries are involved in the Securities Market:

• Stock-brokers and sub-brokers

• Syndicate members
• Portfolio managers
• Debenture Trustees
• Depository Participant
• Credit Rating Agencies
• Investment Advise rs
• Custodians
REGULATORY FRAMEWORK GOVERNING INDIAN CAPITAl MARKET:

The four main legislations governing the securities market are:

1. SEBI Act, 1992

2. Securities Contracts ( Regulation} Act, 1956
3. Depositories Act, 1996
4. Companies Act, 2013

SEBI Act, 1992:

The SEBI Act, 1992 establishes SEBI wih statutory powers for-

1. Protecting the interest of investors in securities.

2. Promoting the development of the securit ies market, and
3. Regulating the securities market

Securities Contracts ( Regulation) Act, 1956:

It provides for direct and indirect control of virtually all specified all aspects of
securities trading and the runnin of stock exchanges and aims to prevent undesirable
transaction in securities. It gives Central government/ SEBI regulatory jurisdiction
over-

1. Stock Exchanges though a process of recognition and continued supervision

2. Contracts in securities, and
3. Listing of Securities on Stock Exchanges

Depositories Act, 1996:

The Depositories Act, 1996 provides for the establishment of depositiories in

securities with the objective of ensuring free transferability of securities with speed,
accuracy and security by-

1. Making securities of public limited companies freely transfera ble subject to

certain exceptions,
2. Dematerializing the securities in the depository mode, and
3. Providing for maintenance of ownership records in a book entry form.

Companies Act, 2013:

The Companies Act, 2013 has replaced the Companies Act, 1956. The new
Companies Act, 2013 envisage to strengthen the existing requlatory framework on
Corporate Governance. It deals with the issue, allotment and transfer of securities
and various aspects relating to company management.
CONCLUSION:

•!• Financial Market is a place or a system where financial assets or instruments

are created and exchanged (bought and sold) by market participants.
•!• Capital market is the financial market fo r the buying and selling of the long
term debt or equity backd securities. It can be divided into;
1. Primary Market
2. Secondary Market
•!• The money market refers to the market where borrowers and lenders
exchange short-term funds to solve their liquidity needs.

Flow of funds (savings) Suppliers of

(mainly business funds
firms and (mainly
Flow of financial services
governments) hou seholds)

Income and financial claims