Capital Market – Meaning, Types, Functions and Instruments

Capital Market Meaning types functions

Capital market helps commercial development of the country by meeting the long-term capital requirement of firms. It is a market for medium and long-term funds. It channelizes savings into investment or productive use. It intermediates flow of savings of those who save a part of their income to those who wants to invest it in productive assets

What is Capital Market?

The term capital market refers to facilities and institutional arrangements through which long-term funds, both debt and equity are raised and invested. It consists of a series of channels through which savings of the community are made available for industrial and commercial enterprises and for the public in general.

Functions of Capital Market

The main functions of capital market are:

  • Mobilisation of financial resources: It mobilizes saving from various sections of the society and makes them available for capital needs of industry, trade and business. Thus, it acts as link between savers and investors.
  • Promotes Industrial Development: It promotes industrial development by providing adequate, cheap and diversified capital to the industrial sector. This capital is used for diversified purposes such as for expansion, modernization, upgradation of technology, establishment of new units etc.
  • Promotes habit of savings: It encourage habit of saving among people as it provides more profitable avenues for investment.
  • Promotes economic growth: It allocates resources as per development needs of the country, which leads to expansion of trade and industry in both public and private sectors, thus promoting balanced economic growth in the country.
  • Effective allocation of the mobilised financial resources: It directs the flow of savings into most profitable ventures and ensures optimum utilisation of financial resources

Types of Capital Market

There are two types of capital market:

  1. Primary market
  2. Secondary market

What is Primary Market?

Primary market is the place where a company publicly sells new stocks and bonds for the first time. This market is also called new issues market. The new issue takes the form of an initial public offering (IPO) or Follow-on Public Offer (FPO). The companies use these funds for investment in building, plants and machinery etc. It helps in setting up of new business unit or expansion of existing business. Thus, it helps in capital formation of the country.

Initial Public Offering (IPO): IPO is a process by which a company issues shares to the public for the first time to raise money. After IPO process is over, the company gets listed on stock exchange and starts trading publicly.

Follow-on Public Offer (FPO): The subsequent issuance of shares by the company is called FPO. The FPO is issued after IPO. The company issues further shares to public to seek additional funding.

What is Secondary Market?

The secondary market is a place where securities are traded after the company has sold its offering on the primary market. It is commonly referred as stock market. In this market, securities are not directly issued by the company to investors. The securities are sold by existing investors to other investors. The sale and purchase are generally done through stock exchange.

The companies do not get additional capital in this market as securities are bought and sold between investors only so there is no direct capital formation. It provides liquidity to securities.

Stock Exchange

A stock exchange lists the securities issued by companies. It refers to exchange of stocks between buyers and sellers. Its function is to provide ready and continuous market for securities. It is defined as an organisation established for the purpose of assisting, regulating and controlling of business in buying, selling and dealing in securities. A stock exchange is situated at particular location.

The main function of stock exchange is:

  • Liquidity and marketability of securities: The main function of stock market is to provide ready market for sale and purchase of securities. The presence of stock exchange market assures the investors that their investment can be converted into cash whenever they want.
  • Barometer of economy: It helps in measuring the economic condition of the country. Any change in economy is reflected in the prices of shares. The rise or fall in the share prices indicates the boom or recession cycle of the economy
  • Fair price determination: It helps to value the securities on the basis of demand and supply factors. The shares of profitable and growth-oriented companies are valued higher as there is more demand for such securities.
  • Safety of Transaction: The members of stock exchange are regulated by defined legal framework. This ensures that the investing public gets a safe and fair deal on the market.

There are 24 stock exchanges in India. The Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE) are stock exchanges where most of the trading in the Indian stock market takes place.

Capital Market Instruments

The common instruments used in capital market are:

  • Shares
  • Debentures

What is Share or Stock?

The Share also referred as Stock is the fractional ownership in Company. The capital of a company is divided into a number of indivisible units of a fixed amount. These units are known as ‘shares. There are two kinds of shares can be issued by a company:

  1. Equity Share: The shares which do not enjoy any preferential right in the matter of payment of dividend or repayment of capital are known as equity shares. After satisfying the rights of preference shares, the equity shares shall be entitled to share in the remaining amount of distributable net profits of the company. Equity shares, have voting rights at all general meetings of the company.
  2. Preference Share: Preference shares are shares having preferential rights to claim dividends during the lifetime of the company and to claim repayment of capital on wind up. Preference shareholders get fixed rate of dividend. They do not have voting rights

What is Debenture?

The debenture is debt instrument issued by companies to borrow money for expansion. It is issued as certificate containing date of redemption and amount of repayment mentioned on it. It carries fixed rate of interest payable half-yearly or yearly basis. The company have to pay interest on debentures even if it is in loss, thus is in expense for the company. The debenture holders do not enjoy ownership rights over the company. They are creditors of company.

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