Dynamics of India's Capital Market: Structure, Functions, and Advantages
Introduction:
The capital market is a financial market where individuals or organizations buy and sell long-term debt or equity-backed securities. Suppliers in this market are those who have the capital to lend or invest, with common examples being banks and investors. In India, the Securities Exchange Board of India (SEBI) governs the capital market.
Structure of the Capital Market in India
Types of Capital Markets
There are two types of markets:
1. Primary market: This is the new issue market where companies issue shares for the first time through an Initial Public Offering (IPO). Once the IPO is successful, the company's shares are listed on the stock exchange. Money in the primary market is raised through private placement, rights issues, and prospectus. It is used for the growth and expansion of the company.
2. Secondary market: This is a market for trading listed shares and securities. Stock exchanges, such as the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), are the usual marketplaces for buying and selling securities. The majority of equity trading and investments in India take place on these two exchanges. NSE and BSE are perfect examples of secondary markets.
Instruments
The capital market consists primarily of five types of instruments:
1. Stocks: Stocks represent ownership in a company, with each share being a part of that ownership. Shares are traded on the stock exchange, and their price depends on market demand and supply. Shareholders receive dividends and have voting powers in the company's annual general meetings. They also receive a share of the assets after liabilities are paid off during liquidation.
2. Bonds: Bonds are debt securities traded on the stock exchange. Companies and firms issue bonds to raise money for their growth and expansion. Bondholders receive interest, and at the end of the maturity period, the company pays back the principal amount along with interest.
3. Exchange-Traded Funds: Exchange-traded funds are a collection of investors' financial resources used to purchase various capital market instruments, including shares, bonds, and derivatives.
4. Derivatives: Derivatives are instruments in the capital market that derive their values from underlying assets such as currency, bonds, and stocks.
5. Currency: Currency is represented as a financial instrument in foreign markets. There are three types of currency agreements: spot, outright forwards, and currency swaps.
Intermediaries
The following are the intermediaries that facilitate the transfer of money and shares:
1. Brokers: Brokers assist in buying and selling shares for a commission.
2. Stock Exchanges: Stock exchanges like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) provide platforms for trading securities.
3. Regulator: The Securities Exchange Board of India (SEBI) governs the capital markets in India.
Functions of the Capital Market
The capital market plays a crucial role in mobilizing resources, allocating them to useful channels, and contributing to a country's economic progress. Its functions include:
1. Transferring savings from cash and other forms to the financial markets, bridging the gap between capital providers and those who require it.
2. Enabling investors to profit more from greater risks.
3. Stabilizing stock prices and facilitating the mobilization of capital.
4. Providing a continuous availability of funds through platforms like the National Stock Exchange and Bombay Stock Exchange, which also lower the cost of information and transactions.
5. Facilitating the transfer of capital and shares between investors through intermediaries like brokers and traders.
Features of the Capital Market
The capital market has the following features:
1. Safety: Government regulation ensures that capital markets operate under a defined set of rules, making it a safe place for trading.
2. Channelizes savings: Capital markets act as a link between savers and investors, mobilizing savings from savers to industry players and promoting economic growth.
3. Long-term investment: Capital markets provide a platform for long-term investments, allowing investors to invest in capital market instruments for extended periods.
4. Wealth creation: By investing in capital market instruments like shares and bonds, investors can create wealth through the power of compounding.
5. Helping intermediaries: The capital market facilitates the transfer of savings from savers to borrowers, contributing to the business activities of intermediaries like stock exchanges, brokers, and banks.
How Does it Work?
For example, when starting a new business, relying on short-term money market funds is inadequate as it takes a few years to generate continuous revenue. In a capital market, individuals or organizations with surplus funds invest in a business for long-term benefits. Funds are raised through securities issued in the primary market, which are then traded in the secondary market with the help of intermediaries.
Advantages of the Capital Market
The capital market offers the following advantages:
1. Allows transactions between those in need of capital and those with capital.
2. Capital market transactions are more effective.
3. Shares earn dividend income for investors.
4. The value of capital market investments tends to grow in the long term.
5. Bond interest rates are usually higher than those offered by banks.
6. Stock market investments can provide long-term capital gain benefits.
7. Capital market investments can be used as collateral for obtaining loans from banks.
Examples of the Capital Market
Examples of the Indian capital market include:
1. Stock Market: Also known as the equity or share market, it brings together buyers and sellers of stocks, representing ownership claims on businesses.
2. Bond Market: It is a financial space where participants can issue new debt (primary market) or trade debt securities.
3. Currency and Foreign Exchange Markets: The foreign exchange market is a global decentralized platform for trading currencies and determining exchange rates.
Difference between Capital Market and Money Market
The following table summarizes the differences between the capital market and the money market:
Basis of Difference
Capital Market
Money Market
Purpose
Becoming part of the asset base of a firm
Meeting short-term working capital requirements
Function
Long-term credit requirements
Short-term credit requirements
Nature of the Market
Formal and regulated
Informal
Classification
Primary Market and Secondary Market
No subdivision
Instruments
Bonds and Stocks
T-Bills, Commercial Papers, CDs, etc.
To understand the differences in detail, please read our article on Money Market vs Capital Market."