Capital Market
Capital Market
The financial market in an economy is broadly classified into the money market and the capital market. The money market deals with short-term funds, while the Capital Market deals with long-term funds.
The capital market is a market for financial assets that have a long or indefinite maturity period. It provides the channels through which long-term funds, both debt and equity, are raised and invested.
It essentially channels savings into long-term investments, facilitating capital formation in the economy. Key participants include individuals, corporations, banks, financial institutions, insurance companies, and mutual funds.
Financial instruments traded in the capital market include equity shares, preference shares, debentures, bonds, units of mutual funds, etc.
The capital market in India is regulated by the Securities and Exchange Board of India (SEBI).
Distinction Between Capital Market And Money Market
While both capital and money markets are part of the financial system, they differ significantly in terms of the type of instruments traded, maturity period, risk, liquidity, and participants.
| Basis | Capital Market | Money Market |
|---|---|---|
| Maturity of Instruments | Medium and long-term (usually > 1 year, or perpetual) | Short-term (usually up to 1 year) |
| Types of Instruments | Shares, Debentures, Bonds, Mutual Fund Units, etc. | Treasury Bills, Commercial Paper, Certificate of Deposit, Call/Notice Money, Commercial Bills, etc. |
| Risk | Relatively higher risk (e.g., price fluctuations, business risk) | Relatively lower risk (due to short maturity and creditworthiness of issuers) |
| Liquidity | Relatively less liquid (selling instruments may take time and involve price fluctuations) | Highly liquid (instruments are easily and quickly convertible into cash) |
| Expected Return | Generally higher expected return (to compensate for higher risk) | Generally lower return |
| Safety | Relatively less safe | Relatively more safe |
| Volume of Transactions | Generally involves larger volumes and larger amounts | Deals in large amounts but instruments can be smaller denominations (though participants trade in large lots) |
| Purpose | Provides long-term finance for investment in fixed assets, expansion, growth | Provides short-term finance for working capital needs, helps manage temporary liquidity shortages |
| Participants | Individuals, Institutions, Companies, Banks, Brokers, etc. | RBI, Commercial Banks, Financial Institutions, Corporations, Mutual Funds, etc. (fewer participants than capital market) |
Primary Market
The Primary Market (also known as the New Issue Market) is the market where new securities are issued for the first time directly by the company to the investors. In this market, funds flow directly from investors to the company.
Companies raise capital through the primary market for setting up new businesses, expanding existing ones, modernising, or diversifying.
Methods of Raising Funds in the Primary Market:
1. Public Issue: Offering securities (shares or debentures) to the general public. This can be through:
- Initial Public Offer (IPO): When an unlisted company makes a fresh issue of shares or offers its existing shares for sale for the first time to the public.
- Further Public Offer (FPO): When an already listed company makes a fresh issue of shares to the public.
2. Offer for Sale: Securities are first sold by the company to an intermediary (like an investment bank) at a fixed price, and the intermediary then resells them to the public at a higher price.
3. Private Placement: Allotting securities to a select group of institutional investors or individuals, not to the general public. This is faster and less expensive than a public issue.
4. Rights Issue: Offering new shares to existing equity shareholders in proportion to their current shareholding. This allows existing shareholders to maintain their proportion of ownership.
5. Bonus Issue: Allotting fully paid-up bonus shares to existing shareholders free of cost out of accumulated reserves. This is a way of capitalising reserves and rewarding shareholders, but does not bring in fresh funds.
The primary market facilitates the process of capital formation by mobilising funds from investors and making them available to companies for productive purposes.
Example 1. Zomato, a food delivery company, listed its shares on the stock exchange for the first time in 2021 by selling shares to the public. Which market did Zomato use for this purpose, and what was the name of the issue?
Answer:
Zomato used the Primary Market, and the issue was an Initial Public Offer (IPO).
Secondary Market
The Secondary Market is the market where existing securities are traded between investors. It is not a market where companies raise funds directly. Instead, investors buy and sell securities they already own or have acquired from others.
The most important component of the secondary market is the Stock Exchange.
Example: Buying or selling shares of companies like Reliance Industries, TCS, or HDFC Bank through a stock broker on exchanges like the National Stock Exchange (NSE) or Bombay Stock Exchange (BSE).
Functions of the Secondary Market (Stock Exchange):
1. Provides Liquidity and Marketability: Enables investors to easily sell their securities and convert them into cash whenever needed, providing liquidity to investments made in the primary market.
2. Pricing of Securities: Demand and supply forces in the stock market help in determining the price of securities based on the company's performance, industry trends, and economic factors. This serves as a barometer of the economy.
3. Safety of Transaction: Stock exchanges operate under the regulations of SEBI and have rules and procedures to ensure fair and safe trading practices, protecting investors' interests.
4. Contributes to Economic Growth: By providing liquidity, the secondary market encourages investors to invest in the primary market, thus facilitating capital formation and economic growth.
5. Spreading of Equity Cult: Helps in educating the public about investment in securities and encourages wider participation in the capital market.
6. Provides Scope for Speculation: While regulated, speculation (buying and selling securities with the expectation of short-term price movements) is a part of the stock market, contributing to market liquidity (though excessive speculation can be detrimental).
Example 2. Ms. Kavita owns 100 shares of State Bank of India (SBI). She decides to sell these shares. She contacts her stockbroker, who executes the sale order on the National Stock Exchange (NSE). To which market does this transaction belong?
Answer:
This transaction belongs to the Secondary Market. Ms. Kavita is selling existing shares to another investor through a stock exchange (NSE).
Example 3. Explain how the secondary market helps in capital formation, even though companies do not directly raise funds from it.
Answer:
The secondary market contributes to capital formation indirectly by providing liquidity to investments made in the primary market. If investors know they can easily sell their shares or debentures on a stock exchange, they are more willing to invest in new issues in the primary market. This willingness to invest in new issues makes it easier for companies to raise funds for expansion and growth, thus facilitating capital formation.