Introduction of Capital Market
A capital market is a financial market in which investors buy and sell financial securities, such as stocks and bonds. These transactions take place through various exchanges. A stock market, for example, is an exchange where stock brokers and traders buy and sell stocks of public companies. A bond market is an exchange where traders buy and sell bonds issued by corporations, governments, or other entities.
The primary function of the capital market is to bring together investors who buy securities with those who sell them. The three main participants of the capital markets are savers (also known as investors), borrowers, and stockholders.
The term capital market includes the stock market, bond market, and related markets. The term is frequently used with reference to banks and banking in both a narrow and broad sense. In the United States, the term is sometimes used to include markets for saving and loans as well as bonds. The units invested may be of any country.
Characteristics of Capital Market
As the capital market is the primary source where the finance is raised for financing the activities of any business, the following characteristics must be present in the capital market to make it effective.
The various characteristics of capital market are as follows:
Some of the important characteristics of a capital market are following:
Security is the basic requirement for any kind of investment to make a profit. Securities are the financial instruments that carry all the information about the underlying assets, liabilities, income, and expenses.
Brokers and dealers play an important role in the capital market. They act as middlemen, that is, they buy and sell securities for their customers. The brokers and dealers make their profit by collecting the brokerage fees, which is a small percentage of the overall transaction value.
Competition among the market players is a key factor in the capital market.
An active and competitive market is very important as it ensures that the buyers and sellers get the best price for their investment. There must be a proper system of transfer of ownership of securities so that they can easily change hands.
What are the Different Instruments of the Capital Market?
The types of capital market instruments are broadly classified into two types -
Equity Security
Equity Shares
These shares are the prime source of finance for a public limited or joint-stock company. When individuals or institutions purchase them, shareholders have the right to vote and also benefit from dividends when such an organization makes profits. Shareholders, in such cases, are regarded as the owners of a company since they hold its shares.
Preference Shares
These are the secondary sources of finance for a public limited company. As the name suggests, holders of such shares enjoy exclusive rights or preferential treatment by that company in specific aspects. They are likely to receive their dividend before equity shareholders. However, they do not typically have any voting rights.
Debt Security
It is a fixed income instrument, primarily issued by sovereign and state governments, municipalities, and even companies to finance infrastructural development and other types of projects. It can be viewed as a loaning instrument, where a bond’s issuer is the borrower.
Bonds
Bondholders are considered as creditors concerning such an entity and are entitled to periodic interest payment. Furthermore, bonds carry a fixed lock-in period. Therefore, issuers of bonds are mandated to repay the principal amount on the maturity date to bondholders.
Debentures
Unlike bonds, debentures are unsecured investment options. Consequently, they are not backed by any asset or collateral. Here, lending is entirely based on mutual trust, and, herein, investors act as potential creditors of an issuing institution or company.
All these four instruments are parts of the capital market. Since each is unique and has distinguishing features, they are useful in different ways for a company. Therefore, it is crucial to understand the different types of capital market instruments so that you can acknowledge their purposes.
What are the Functions of the Capital Market?
Irrespective of the capital market and its types, their functions are similar. These are listed below -
Enhance trading of securities
Provides a common platform to both investors and savers
Accumulation of capital for companies that need them
Stimulates economic growth
It improves the process of allocation of capital
Prepares for continuity of funds availability
It reduces information and transaction charges significantly.
Faster valuation of securities.
Provides proper channeling of funds to be used productively.
Therefore, the capital market is an effective medium for mobilizing funds between investors and sellers. With the functions listed above, it is evident that the capital market is not only a platform for fund transfer but also has its long-term advantages.
It is useful in boosting national incomes, thereby enhancing the overall economic growth of a nation as a whole. As a result, you will need to understand the concepts from the grassroots to get an in-depth idea of a capital market meaning and types, functions, and significance.
What are the Types of Capital Market?
The types of the capital market – primary and secondary are essential to understand for Commerce students. Additionally, there are other divisions of the capital market based on the traded security type - bond market and the stock market.
Herein, we will focus on the former division of capital market types - primary and secondary markets.
Primary Market
Herein, the trading takes place for new securities. Companies go public for the first time in this market allows entities outside the locus of an organization to purchase their shares. This phenomenon is called Initial Public Offering or IPO.
Secondary Market
Between the types of capital markets, it deals with securities that have already been traded in the primary market. New York Stock Exchange (NYSE), Bombay Stock Exchange (BSE), National Stock Exchange (NSE), etc. are secondary markets.
To understand these clearly, students should grow an understanding of the types of capital in business as well.
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FAQs on Types of Capital Market: Primary and Secondary Markets
1. What is a capital market, and what are its two main types?
A capital market is a financial market where long-term funds (for more than a year) are raised by companies and governments. It acts as a bridge between those with surplus capital (savers/investors) and those who need it for productive purposes. The capital market is primarily divided into two main types: the Primary Market, where new securities are issued, and the Secondary Market, where existing securities are traded.
2. Explain the role of the primary market with a real-world example.
The primary market is also known as the New Issue Market (NIM). Its main role is to facilitate capital formation by allowing companies to issue and sell brand-new securities directly to investors to raise fresh capital. A classic example is an Initial Public Offering (IPO). When a private company like Zomato or LIC first offered its shares to the public to raise funds for expansion, it was done through the primary market.
3. What is the secondary market and why is it also called the stock market?
The secondary market is a platform where previously issued securities are bought and sold among investors. The company that issued the securities is not directly involved in these transactions. It is often called the stock market because stocks (or equity shares) are the most prominent securities traded on these platforms. Major examples in India include the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), which are primarily known for stock trading.
4. What are the key differences between the primary market and the secondary market?
The primary and secondary markets are distinct but interconnected. The key differences are:
Securities: The primary market deals with new securities being issued for the first time. The secondary market trades existing securities.
Parties Involved: In the primary market, the transaction is between the company and the investor. In the secondary market, transactions occur between two investors.
Capital Formation: The primary market directly contributes to capital formation as funds flow to the company. The secondary market provides liquidity but does not directly raise funds for the company.
Price Determination: Prices in the primary market are fixed by the company's management. In the secondary market, prices are determined by the market forces of demand and supply.
5. How does a company raise funds from the public in the primary market?
A company can raise funds in the primary market using several methods, as per the CBSE 2025-26 syllabus. The most important methods of floatation are:
Offer Through Prospectus (IPO): This involves inviting the public to subscribe to its securities by issuing a detailed document called a prospectus.
Offer for Sale: Securities are offered for sale to the public through intermediaries like stockbrokers and issuing houses.
Private Placement: The company sells its securities to a select few institutional investors or wealthy individuals rather than to the general public.
Rights Issue: New shares are offered to existing shareholders in proportion to their current holdings.
e-IPOs: Issuing capital to the public through an online system of the stock exchange.
6. Why is a healthy secondary market crucial for the success of the primary market?
A healthy secondary market is crucial because it provides liquidity and marketability to securities issued in the primary market. Investors are more willing to buy securities in an IPO (primary market) if they know they can easily sell them later in the secondary market. Without a functioning secondary market, investors would be locked into their investments indefinitely, making them hesitant to invest in new issues. Thus, the secondary market creates the demand and confidence needed for the primary market to thrive.
7. How is the price of a security determined in the secondary market?
In the secondary market, the price of a security is not fixed by the company. Instead, it is determined by the continuous interaction of demand and supply forces for that security on a stock exchange. If there are more buyers than sellers for a stock, its demand increases, leading to a rise in its price. Conversely, if there are more sellers than buyers, the supply exceeds demand, causing the price to fall. This dynamic process is known as price discovery.
