Capital market

The capital market is a segment of the financial system where long-term funds are raised and invested. It serves as a vital mechanism for mobilising savings from individuals and institutions and channeling them into productive investments such as businesses, infrastructure, and government projects. Unlike the money market, which deals with short-term funds (less than one year), the capital market focuses on long-term financing, typically exceeding one year.
The capital market plays a central role in economic development by facilitating investment, enhancing liquidity, and providing a platform for companies to raise equity or debt capital.

Definition

The capital market can be defined as a marketplace for trading financial instruments such as shares, debentures, bonds, and other long-term securities. It connects investors, who seek profitable avenues for savings, with borrowers (corporations and governments) who require funds for expansion, operations, and development.
According to the Securities and Exchange Board of India (SEBI):

“The capital market is a market for securities where companies and governments can raise long-term funds and investors can buy and sell these instruments.”

Structure of the Capital Market

The capital market is broadly divided into two segments:

1. Primary Market (New Issue Market):
   • The primary market deals with the issue of new securities.
   • Companies raise fresh capital by issuing shares, debentures, or bonds to investors for the first time.
   • Common instruments include Initial Public Offerings (IPOs), Follow-on Public Offers (FPOs), and private placements.
   • It facilitates capital formation by transferring savings into productive investments.
2. Secondary Market (Stock Market):
   • The secondary market provides a platform for buying and selling existing securities among investors.
   • It ensures liquidity and marketability of investments, allowing investors to convert holdings into cash easily.
   • It operates through stock exchanges, such as the National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) in India, or the London Stock Exchange (LSE) and New York Stock Exchange (NYSE) internationally.

Together, these markets ensure a continuous flow of funds and stability in the financial system.

Participants in the Capital Market

The capital market involves a wide range of participants, including:

• Corporations: Issue shares or bonds to raise long-term finance.
• Government and Public Sector Entities: Issue securities such as government bonds to fund public projects.
• Investors: Individuals, institutions, and foreign investors seeking capital appreciation or income.
• Intermediaries: Financial institutions, stockbrokers, investment banks, underwriters, and mutual funds that facilitate transactions.
• Regulatory Authorities: Bodies such as SEBI (India), FCA (UK), and SEC (USA) that oversee and regulate market operations.

Instruments Traded in the Capital Market

Capital markets offer a variety of long-term financial instruments, including:

• Equity Shares: Represent ownership in a company and provide dividends and voting rights.
• Preference Shares: Offer fixed dividends but limited voting rights.
• Debentures and Bonds: Long-term debt instruments that provide periodic interest payments and repayment of principal at maturity.
• Government Securities (G-Secs): Issued by governments to fund fiscal deficits or infrastructure projects.
• Mutual Funds: Collective investment schemes that pool investor money to purchase diversified portfolios.
• Derivatives: Financial contracts such as futures and options based on underlying assets like stocks, indices, or bonds.

Functions of the Capital Market

The capital market performs several essential functions in the economy:

1. Mobilisation of Savings:
   • Encourages individuals and institutions to invest surplus funds in productive ventures.
2. Capital Formation:
   • Converts savings into investments, thereby increasing the productive capacity of the economy.
3. Liquidity and Transferability:
   • Enables investors to buy and sell securities, ensuring flexibility and liquidity of investments.
4. Efficient Allocation of Resources:
   • Directs funds towards the most productive and profitable enterprises.
5. Price Discovery:
   • Determines fair prices of securities through demand and supply interactions in the market.
6. Risk Diversification:
   • Offers investors various instruments to spread and manage financial risk.
7. Economic Growth:
   • Facilitates business expansion, infrastructure development, and innovation by providing access to long-term finance.

Importance of the Capital Market

• For the Economy:
  • Supports national economic growth by financing industrial and infrastructure development.
  • Provides a mechanism for governments to manage deficits and fund development programmes.
• For Businesses:
  • Offers a cost-effective alternative to bank financing.
  • Enhances corporate visibility and governance through public listings.
• For Investors:
  • Enables wealth creation through capital appreciation and dividend income.
  • Provides liquidity and a variety of investment choices with different risk-return profiles.

Types of Capital Markets

1. Stock Market: Deals primarily in shares and equity instruments.
2. Bond Market: Facilitates the trading of debt securities issued by governments and corporations.
3. Foreign Exchange Market (long-term segment): Handles international capital movements.
4. Derivatives Market: Allows risk management through contracts such as futures and options.

These sub-markets collectively ensure a stable and efficient flow of long-term capital across the economy.

Regulation of the Capital Market

Regulatory authorities ensure transparency, fairness, and investor protection. In India, the Securities and Exchange Board of India (SEBI) regulates and monitors the capital market.
Key regulatory functions include:

• Registering and supervising intermediaries.
• Preventing insider trading and fraudulent practices.
• Ensuring timely disclosures and corporate governance.
• Promoting investor education and awareness.

Globally, capital markets are regulated by organisations such as the U.S. Securities and Exchange Commission (SEC) and the UK Financial Conduct Authority (FCA).

Advantages of a Developed Capital Market

• Promotes economic development through long-term financing.
• Encourages foreign investment and cross-border capital flows.
• Provides price stability and liquidity in financial instruments.
• Improves corporate efficiency through market discipline.
• Enables government borrowing through bond issuance.

Challenges in Capital Markets

Despite its importance, the capital market faces several challenges:

• Market volatility due to global and domestic factors.
• Insufficient financial literacy among retail investors.
• Speculative trading leading to artificial price movements.
• Regulatory lapses or delays in enforcement.
• Limited participation from rural and small investors in emerging markets.

Continuous reforms and technological improvements are essential to address these challenges and maintain market integrity.

Capital Market in India

The Indian capital market has undergone significant transformation since liberalisation in the early 1990s. Major developments include:

• Establishment of SEBI (1988, statutory status in 1992).
• Introduction of electronic trading through NSE (1994) and dematerialisation of securities.
• Expansion of mutual funds and exchange-traded funds (ETFs).
• Launch of derivatives trading (2000).
• Foreign portfolio investment liberalisation.

India’s capital market now ranks among the most active in the world, with increased participation from domestic and international investors.

Example of Capital Market Operation

When a company like Infosys issues new shares through an Initial Public Offering (IPO), investors purchase them in the primary market. Once listed, these shares can be traded daily on exchanges such as NSE or BSE in the secondary market, allowing price discovery and liquidity.
Thus, both markets work together to provide continuous funding and trading opportunities.