What is Capital Market? : Meaning, Types and Functions

8 Mins

A capital market is a financial market where long-term debt or equity-backed securities are bought and sold. Suppliers are people/organisations with the capital to lend or invest. Banks and investors are common examples. Securities Exchange Board of India (SEBI) governs the capital market in India.

Structure of Capital Market in India

Types of Capital Markets

Two types of markets:

Primary market: It 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 shares of the company get listed on the stock exchange. Money in the primary market is raised through private placement, rights issues, and prospectus. The money is raised for the growth and expansion of the company.
Secondary market: It is a market for trading listed shares and securities. A stock exchange is usually the marketplace for buying and selling securities. In India, the major stock exchanges are National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) and a majority of equity trading and investments take place on these two exchanges. NSE and BSE are perfect examples of secondary markets.

Instruments

The market consists majorly of five types of instruments:

Stocks: Stocks represent ownership of a company. Each share is a part of the ownership of the company. Shares trade on the stock exchange, and the share price depends on market demand and supply. The person holding shares of a company is the shareholder. Shareholders receive dividends. Also, in the case of equity shares, they have voting powers and can vote for important decisions in the annual general meeting of the company. During liquidation, they get a share of the assets after the liabilities are paid off.
Bonds: Bonds are debt securities that trade on the stock exchange. Companies and firms issue bonds to raise money for the growth and expansion of the company. Bonds are debt instruments, hence bondholders receive interest. At the end of the maturity period, the company pays back the principal amount along with interest.
Exchange-Traded Funds: Exchange-traded funds are a collection of investors’ financial resources used to purchase a variety of capital market instruments, including shares, debt securities like bonds, and derivatives.
Derivatives: Derivatives are the instruments of the capital market that derive their values from the underlying assets. These assets include currency, bonds, stocks, etc.
Currency: Foreign markets represent currency as a financial instrument. Spot, outright forwards and currency swap are the three types of currency agreements.

Intermediaries

The following are the intermediaries:

Financial intermediaries are the organisations that assist in the transfer of money. They serve as a link between the surplus and deficit parties. For example:

Brokers: A broker assists in buying and selling shares for a commission.
Stock Exchanges: For example, National Stock Exchange (NSE), Bombay Stock Exchange(BSE), etc
Regulator: Securities Exchange Board of India (SEBI) governs the capital markets in India.

Functions of a Capital Market

A capital market is for long-term financial assets. It plays a crucial role in mobilising resources and allocating them to useful channels. Therefore, the capital market helps a country’s economic progress.

The following are the functions:

It transfers savings from parties in cash and other forms to the financial markets. It fills the gap between those who provide capital and those who require it.
Investors can profit more from greater risks.
Capital Markets also assist in stabilising stock prices in addition to facilitating the mobilisation of capital. For instance, exchange instruments like stocks are liquid for participants.
Therefore, the availability of funds is a continuous process. Platforms like the National Stock Exchange and Bombay Stock Exchange help accomplish this. It lowers the price of information and transactions.
Intermediaries like brokers and traders enable the transfer of capital and shares between two investors. This aids them in running their business.

Features of a Capital Market

The following are the features of capital markets:

Safety: Government regulates the capital markets. They operate under a defined set of rules. Therefore, investors consider it a safe place for trading.
Channelizes savings: Capital markets act as a link between savers and investors. They mobilise the savings from savers to industry players and promote economic growth.
Long term investment: Capital markets provide a platform for long term investments. Any investors looking for investing in long term investments can do so through capital markets.
Wealth Creation: The capital market provides an opportunity to investors with surplus funds to invest in capital market instruments like shares and bonds and create wealth for themselves through the power of compounding.
Helps intermediaries: The capital market mobilises savings from savers to borrowers with the help of intermediaries like stock exchanges, brokers, banks, etc. By doing so, the capital market is helping intermediaries conduct business and earn income.

How Does it Works?

Taking a brief example, It takes a few years to start generating continuous revenue when you start a new business. One can’t rely on short-term money market funds like commercial papers, bills and treasuries to manage business expenses.

Therefore, in a capital market, an individual or organisation with surplus funds agrees to invest in a business for the long-term benefits of both parties. Securities are issued in the primary market to raise funds. After researching the company, interested individuals purchase those shares through the IPO procedure. These initial shares are then traded in the secondary market. Intermediaries enable this process.

Advantages of Capital market

The following are the advantages of the capital market:

Transaction happens between those who need capital and those who have the capital.
Capital market transactions are more effective.
Shares earn dividend income for investors.
In the long term, the growth in the value of capital market investments is high.
The interest rates from bonds are higher than the interest rates offered by banks.
Long-term capital gain benefits are available for stock market investments.
Capital market investments can be used as collateral for getting loans from banks.

Example of Capital Market

Following are examples of Indian capital market:

Stock Market: The stock market, also known as the equity or share market, brings together buyers and sellers of stocks, representing ownership claims on businesses.
Bond Market: The bond market is a financial space where participants can issue new debt (primary market) or trade debt securities.
Currency and Foreign Exchange Markets: The foreign exchange market is a global decentralized platform for trading currencies, determining exchange rates for every currency.

Difference between Capital Market and Money Market

The following table summarizes some differences between the capital market and the money market:

Basis of Difference	Capital Market	Money Market
Purpose	Become part of the asset base of the firm.	To meet 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, read our article Money Market vs Capital Market.

Frequently Asked Questions

Are capital markets the same as financial markets?

There are some key differences between these two concepts. Financial markets are often secondary markets, including a wide range of locations where people and organisations exchange assets, securities, and contracts. On the other hand, capital markets are largely used to raise funds, typically for a company, and a company’s growth.

How do businesses use the capital market to raise money?

Companies obtain equity capital through an Initial Public Offering (IPO). They may also look for private placements from an angel or venture capital investors. Two ways to raise debt capital are bank loans and the issuance of securities in the bond market.

Who are the intermediaries in the capital market?

Intermediaries are firms that facilitate the transfer of funds between investors and companies or between two investors. The key financial intermediaries in India are Banks, Insurance Companies, Pension Funds, Mutual Funds and the stock exchange.

Who Controls the Capital Market in India?

The three regulatory bodies that control the Indian capital market are the Reserve Bank of India (RBI), the Securities & Exchange Board of India (SEBI), and the Ministry of Finance (MoF).

What is the role of SEBI in capital markets?

The Indian Capital Markets are effectively monitored and governed by the Securities Exchange Board of India (SEBI). The government has established the SEBI as a regulating organisation to stop the malpractices such as false issues, supply delays, and violations of stock market rules and regulations.
The SEBI’s responsibilities and goals are:
1. Control the activities of transfer agents, stock brokers, commercial bankers, etc.
2. Monitor how securities markets and stock exchanges operate.
3. Promote the establishment of Self-regulatory Organisations.
4. Create guidelines to prevent misconduct
5. SEBI has outlawed internal trading, which gives certain traders an advantage over others.