WHAT IS A CAPITAL MARKET?

Capital market is a place where buyers and sellers indulge in trade (buying/selling) of financial
securities like bonds, stocks, etc. The trading is undertaken by participants such as individuals
and institutions.

Capital market trades mostly in long-term securities. The magnitude of a nation’s capital markets
is directly interconnected to the size of its economy which means that ripples in one corner can
cause major waves somewhere else.

Types of Capital Market

Capital market consists of two types i.e. Primary and Secondary.

1. Primary Market
Primary market is the market for new shares or securities. A primary market is one in
which a company issues new securities in exchange for cash from an investor (buyer).It
deals with trade of new issues of stocks and other securities sold to the investors.

2. Secondary Market
Secondary market deals with the exchange of prevailing or previously-issued securities
among investors. Once new securities have been sold in the primary market, an efficient
manner must exist for their resale. Secondary markets give investors the means to resell/
trade existing [Link] important division in the capital market is made on the
basis of the nature of security sold or bought, i.e. stock market and bond market.

 A capital market provides individuals and firms with an avenue to raise funds for their needs and
wants. It is of two types – primary market and secondary market.
 The market plays a crucial role in economic development. It mobilizes savings from individuals,
banks, financial institutions, real estate, and gold, thus diverting savings from unproductive
channels to productive areas.
 Commercial banks, financial institutions, individual investors, insurance companies, business
corporations, and retirement funds are the major suppliers of funds in the market.
 There are usually long-term investments here, such as shares, shares, debt, government
securities, debentures, bonds, etc. Stock exchanges operate the market predominantly.

How Does a Capital Market Work?

A capital market assists an economy by providing a platform to gain funds for business
operations, development activities, or wealth enhancement. The functioning of a capital market
follows the theory of the circular flow of money.
 For example, a firm needs money for business operations and usually borrows it from
households or individuals. In the capital market, the money from individual investors or
households is invested in a firm’s shares or bonds. In return, investors gain profits as well as
goods and services.
The market comprises suppliers and buyers of finance, along with trading instruments and
mechanisms. There are also regulatory bodies. Stock exchanges, equity markets, debt markets,
options markets, etc., are some capital market examples.
Elements of a Capital Market

 Individual investors, commercial banks, financial institutions, insurance companies, business

corporations, and retirement funds are some significant suppliers of funds in the market.
 Investors offer money intending to make capital gains when their investment grows with time. In
addition, they enjoy perks like dividends, interests, and ownership rights.
 Companies, entrepreneurs, governments, etc., are fund-seekers. For instance, the government
issues debt instruments and deposits to fund the economy and development projects.
 Usually, long-term investments such as shares, debt, government securities, debentures, bonds,
etc., are traded here. In addition, there are also hybrid securities such as convertible debentures
and preference shares..
 Stock exchanges operate the market predominantly. Other intermediaries include investment
banks, venture capitalists, and brokers.
 Regulatory bodies have the authority to monitor and eliminate any illegal activities in the capital
market. For instance, the Securities and Exchange Commission overlooks the stock exchange
operations.
 The capital market and money market are not the same. Securities exchanged in the former
would typically be a long-term investment with over a year lock-in period. Short-term
investments trade in the money markets and include a certificate of deposits, bills of
exchange, promissory notes, etc.

Functions of Capital Market

 It mobilizes parties’ savings from cash and other forms to financial markets. It bridges the gap
between people who supply capital and people in need of money.
 Any initiative requires cash to materialize. Financial markets are central to national and
economic development as they provide rich sources of funds. For example, the World Bank
collaborates with global capital markets to mobilize funds to achieve its goals, such as poverty
elimination.
 The International Bank for Reconstruction and Development (IBRD) has assisted over 70
countries by raising nearly $ 1 trillion since the first bond in 1947. Likewise, a report suggested
that the European Union companies need to turn to this market to manage their pandemic
balance sheet as banks alone will not suffice.
 For the participants, the exchange instruments possess liquidity, i.e., they can be converted
into cash and cash equivalents.
 Also, the trading of securities becomes easier for investors and companies. It helps minimize
transaction and information costs.
 With higher risks, investors can gain more profits. However, there are many products for those
with a low-risk appetite. In addition, there are some tax benefits obtained from investing in the
stock market.
 Usually, the market securities can work as collateral for getting loans from banks and financial
institutions.

Downsides

 Investments in shares and mutual funds are deemed risky as the investment is highly volatile
due to market fluctuations. Therefore, there is a massive chance of losing money to market
risks.
 Market fluctuations risk one’s investments and hinder a fixed income. Those who are investing
their hard-earned savings, such as retired employees and senior citizens, will prefer the safety of
their funds to high earnings.
 With the wide range of investment alternatives present in the market, an investor may not make a
fruitful choice without professional advice.
 Trading of securities may involve a brokerage fee, commission, etc., increasing the cost of
transactions.

Meaning of Stock Exchange

A stock exchange is an important factor in the capital market. It is a secure place where trading is
done in a systematic way. Here, the securities are bought and sold as per well-structured rules
and regulations. Securities mentioned here includes debenture and share issued by a public
company that is correctly listed at the stock exchange, debenture and bonds issued by the
government bodies, municipal and public bodies.

Typically bonds are traded Over-the-Counter (OTC), but a few corporate bonds are sold in a
stock exchange. It can enforce rules and regulation on the brokers and firms that are enrolled
with them. In other words, a stock exchange is a forum where securities like bonds and stocks
are purchased and traded. This can be both an online trading platform and offline (physical
location).

Functions of Stock Exchange

Following are some of the most important functions that are performed by stock exchange:

1. Role of an Economic Barometer: Stock exchange serves as an economic barometer

that is indicative of the state of the economy. It records all the major and minor changes
in the share prices. It is rightly said to be the pulse of the economy, which reflects the
state of the economy.
2. Valuation of Securities: Stock market helps in the valuation of securities based on the
factors of supply and demand. The securities offered by companies that are profitable and
growth-oriented tend to be valued higher. Valuation of securities helps creditors,
investors and government in performing their respective functions.
 3. Transactional Safety: Transactional safety is ensured as the securities that are traded in
the stock exchange are listed, and the listing of securities is done after verifying the
company’s position. All companies listed have to adhere to the rules and regulations as
laid out by the governing body.
4. Contributor to Economic Growth: Stock exchange offers a platform for trading of
securities of the various companies. This process of trading involves continuous
disinvestment and reinvestment, which offers opportunities for capital formation and
subsequently, growth of the economy.
5. Making the public aware of equity investment: Stock exchange helps in providing
information about investing in equity markets and by rolling out new issues to encourage
people to invest in securities.
6. Offers scope for speculation: By permitting healthy speculation of the traded securities,
the stock exchange ensures demand and supply of securities and liquidity.
7. Facilitates liquidity: The most important role of the stock exchange is in ensuring a
ready platform for the sale and purchase of securities. This gives investors the confidence
that the existing investments can be converted into cash, or in other words, stock
exchange offers liquidity in terms of investment.
8. Better Capital Allocation: Profit-making companies will have their shares traded
actively, and so such companies are able to raise fresh capital from the equity market.
Stock market helps in better allocation of capital for the investors so that maximum profit
can be earned.
9. Encourages investment and savings: Stock market serves as an important source of
investment in various securities which offer greater returns. Investing in the stock market
makes for a better investment option than gold and silver.

Features of Stock Exchange:

 A market for securities- It is a wholesome market where securities of government,

corporate companies, semi-government companies are bought and sold.
 Second-hand securities- It associates with bonds, shares that have already been
announced by the company once previously.
 Regulate trade in securities- The exchange does not sell and buy bonds and shares on
its own account. The broker or exchange members do the trade on the company’s behalf.
 Dealings only in registered securities- Only listed securities recorded in the exchange
office can be traded.
 Transaction- Only through authorised brokers and members the transaction for securities
can be made.
 Recognition- It requires to be recognised by the central government.
 Measuring device- It develops and indicates the growth and security of a business in the
index of a stock exchange.
 Operates as per rules– All the security dealings at the stock exchange are controlled by
exchange rules and regulations and SEBI guidelines.