Definitions and Objectives of the Capital Market
It refers to the part of the market where the financial instructions mobilize the savings of the people and lend them long-term so that new capital can be raised in the country. A capital market is nothing but the process by which funds are borrowed and lent over a long period of time. The capital market can also be considered a marketplace where financial securities (stocks, bonds, and government-backed loans) are bought and sold.
Types of Capital Market
Primary Market
A primary market is the most important type of capital market. It is also known as the new issue market. The primary function of this market is to deal with new securities, i.e. securities that are issued for the first time to a new investor.
Primary markets serve the most important function of generating capital for companies, governments, and institutions. Investors are able to find companies through this service who are interested in investing in their expansion or project.
Secondary Market
Another type of market besides primary markets is the secondary market. The stock exchange market is usually called the secondary market. There are securities on the market in the form of shares, debentures, bonds, bills, etc., which are bought and sold between parties. A primary market deals solely with newly issued securities, whereas a secondary market deals with existing securities. However, the secondary market deals with securities already in existence. The secondary market does not issue new securities.
Regulation and legalization of the securities market ensure strict rules and regulations for the trading of securities. To make sure that investors can trade without fear of being scammed, this step has been taken. Technology has played a major role in advancing secondary capital markets during the last decade.
The Functions of Capital Markets
Capital Formation - Promote savings and make them available to companies and public authorities.
Various financial instruments are available on the capital market that allows economic agents to pool, price, and exchange risks.
Financial savings are encouraged by assets with favorable yields, liquidity characteristics, and risk characteristics.
The stock exchange allows long-term investors to convert their holdings into cash through the market. It also provides companies with securities with the option of obtaining cash without reducing their liquidity.
An important function of the capital market is to mobilize funds and resources needed for development and to implement policies related to stabilization, monetary control, and banking system regulation.
Capital Market Objectives
Capital market regulation is primarily intended to protect investors, insider dealings, creative accounting, and misuse of client money are some of the vices investors need protection from.
Some of the objectives of capital market regulation are as follows:
The protection of investors.
Make sure markets are fair, efficient, and transparent.
Taking steps to reduce systemic risk.
Accordingly, capital market regulation is intended to protect the public interest, which operates on the need to foster economic development and confidence, which in turn can boost inward investment.
Some Methods of Raising Funds
The companies raise money in the primary market through securities such as shares, debentures, loans and deposits, and preference shares, etc. Let us take a look at the various methods of how new securities are floated in the primary market.
Offer Through Prospectus: This method involves public issues. It is widely used in the public method to raise funds. In this method, the companies invite the investors to invest in their company through an advertisement (known as a prospectus).
After issuing a prospectus the public starts investing in shares, debentures, etc. According to the response, shares will be allotted to the public. In case the subscriptions are high, allotment is done on a pro-rata basis. The company shares can be sold to the public. Generally, it hires brokers or underwriters.
Private Placement: This method offers investment opportunities to select some individuals. This is preferred as the public offers are expensive. They provide Investment opportunities to some selected individuals.
So, when the company sells its shares to any financial institution like banks, insurance companies and so on it helps in raising funds quickly, economically, and efficiently. Such a company neither sells nor offers the securities largely to the public.
Rights Issue: Often when a company wants to expand or needs additional funds, it generally first turns to the current investors. Thus, the current shareholders have an opportunity to invest more in the company. They can buy new shares before the public is given a chance.
The allotment of new shares is performed on a pro-rata basis. If the shareholder chooses to let go of this offer then the public is allowed to purchase the shares. If the shareholder wants to purchase the shares then they will acquire more shares.
e-IPO: This means Electronic Initial Public Offer. When a company is willing to offer its shares to the public it can opt for online offers. The company and the relevant stick exchange sign an agreement known as the e-IPO.
SEBI introduced this system in India 3 years ago. This makes the entire process of IPO faster and more efficient. The company will have to work with brokers to accept the received applications. Apart from this, a registrar must be appointed to the issue.
Secondary Market
The other type of market apart from the primary market is the secondary market. This market is more commonly known as the stock market of the stock exchange. This market is inclusive of securities in the form of shares, debentures, bonds, bills etc and these are bought and sold between parties.
The main difference between the primary and the secondary market is that primary markets only deal with new securities that were issued. On the other hand, the secondary market is for trading in existing securities. There are no fresh issues in the dealings of the secondary market.
The trading of securities takes place in a highly regulated and legalized market under strict rules and regulations. This is to make sure that the investors can trade without the fear of scams. During the last decade, technological advancements have resulted in a great boon for the secondary capital market.
FAQs on Capital Market: Features and Importance
1. What is a capital market as per the Class 12 syllabus?
A capital market is a financial marketplace where long-term funds, with a maturity period of more than one year, are raised by governments and corporations. It acts as a crucial link, channelling savings and idle funds from investors to entities that require them for productive, long-term investments like business expansion or infrastructure development.
2. What is the primary importance of a capital market for a country's economy?
The capital market is vital for economic growth and stability. Its primary importance lies in its ability to facilitate capital formation by mobilising public savings and channelling them into productive ventures. This leads to increased industrial production, job creation, and overall economic prosperity. It also provides liquidity to financial assets, making long-term investment more attractive.
3. What are the key features that define a capital market?
The key features of a capital market are:
- Deals in Long-Term Funds: It focuses on financial instruments with a maturity of over one year, such as shares and debentures.
- Link Between Savers and Borrowers: It acts as an intermediary, transferring funds from those with a surplus to those in need of capital.
- Capital Formation: Its main function is to help in the creation of capital by mobilising resources.
- Regulated Environment: It operates under the rules and regulations of a governing body, like SEBI in India, to protect investors.
- Includes Primary and Secondary Markets: It comprises both the market for new issues (primary) and the stock market for existing securities (secondary).
4. What are the common financial instruments traded in the capital market?
The main financial instruments, or securities, traded in the capital market include:
- Equity Shares: These represent ownership in a company and give shareholders voting rights.
- Preference Shares: These provide a fixed rate of dividend and have preferential payment rights over equity shares.
- Debentures: These are debt instruments acknowledging a loan to the company, carrying a fixed interest rate.
- Bonds: Similar to debentures, these are long-term debt instruments typically issued by governments or large corporations.
5. What is the fundamental difference between the primary market and the secondary market?
The fundamental difference lies in the type of transaction. The primary market is where new securities are issued by a company for the very first time to raise fresh capital (e.g., through an Initial Public Offering or IPO). In contrast, the secondary market (or stock market) is where existing, previously issued securities are bought and sold among investors, providing liquidity but not raising new funds for the company.
6. How does the capital market differ from the money market?
The capital market and money market differ mainly on four grounds:
- Maturity Period: Capital market instruments are long-term (over 1 year), while money market instruments are short-term (up to 1 year).
- Purpose of Funds: Capital markets finance fixed capital requirements (e.g., machinery, buildings), whereas money markets address working capital needs.
- Risk Factor: Capital market instruments generally carry higher financial and market risk compared to the relatively safer money market instruments.
- Instruments: The capital market trades in shares, bonds, and debentures, while the money market trades in treasury bills, commercial papers, etc.
7. How does an efficient capital market help in channelling savings into productive use?
An efficient capital market acts as a dynamic pipeline. It gathers scattered savings from households and individuals by offering them attractive investment opportunities like stocks and mutual funds. It then allocates this pooled capital to businesses and entrepreneurs who have viable projects but lack funds. This process ensures that money is not left idle in bank accounts but is actively used to finance innovation, expansion, and infrastructure, driving national economic growth.
8. Why is SEBI's regulatory role considered so important for the health of the Indian capital market?
SEBI's regulatory role is crucial because it fosters investor confidence, which is the bedrock of any capital market. By setting rules for transparency, preventing insider trading, and protecting investors from fraud, SEBI ensures a fair and orderly market. This security encourages both domestic and foreign investors to participate, leading to greater capital availability, market depth, and overall economic stability. Without a strong regulator, the market would be prone to manipulation and instability.
