What Are Capital Markets
Capital markets are the part of the financial system used for long-term funding. Businesses may need money for factories or acquisitions. Governments may borrow for roads, power projects, or other public work. Instead of relying only on bank loans, an issuer can offer shares, bonds, debentures, or another permitted security to investors.
What the investor receives depends on the instrument. A shareholder owns an interest in the company and shares its business risk. A bondholder or debenture holder is a creditor. Issue papers set interest, repayment, security, and other rights. Eligible listed securities may later be sold in the secondary market, although a sale at the desired price is never certain.
Maturity helps draw the line between this market and the money market. The Government of India issues Treasury bills for 91, 182, and 364 days, so they remain short-term instruments. Dated government securities begin at an original maturity of one year. Long-term corporate debt belongs to the capital market even if an investor sells it quickly. Equity has no fixed maturity. In every case, price, credit, and liquidity risk need attention.
How Capital Markets Work
The process is divided among issuers, intermediaries, exchanges, clearing corporations, and depositories. The steps below explain how each stage works.
- The issuer settles the funding need. Management weighs the amount, repayment burden, ownership dilution, tenure, security, and rules before choosing equity, debt, or a permitted hybrid.
- For a public offer, merchant bankers coordinate the work and carry out due diligence. Registrars keep application and allotment records. Bankers and other appointed parties handle their parts of the issue.
- Investors receive the offer document before committing money. Checks include the financial statements, planned use of proceeds, pricing, repayment terms, security, investor rights, and stated risks.
- When the application period ends, the allotment process begins. Successful applicants pay the accepted amount. Securities are then credited in electronic form wherever the relevant law requires it.
- Trading begins once the security is listed. Investors place orders through registered brokers, and a recognized exchange matches compatible buying and selling instructions under its trading rules.
- The trade is not complete at the order match. A clearing corporation calculates what each party owes. Funds and securities then move through settlement, after which depositories update electronic holdings.
Types of Capital Market
Primary Market
The primary market is where a security first reaches investors. Here, money flows to the issuer rather than another investor. A company may use an initial public offering, a further public offer, a rights issue, a preferential issue, or a private placement. The permitted route depends on the company, instrument, and investor group.
The offer papers tell applicants what they are buying. They cover the issuer's finances, use of funds, risks, rights, and pricing details where relevant. Covered public equity issues follow the prescribed three-day listing schedule after closure. Debt issues follow their own timetable and disclosure framework.
Secondary Market
Once a security has been issued, later trades take place in the secondary market. The buyer pays the selling investor; the issuer does not collect the resale price. Prices react to company news, economic data, credit events, and expectations about the repo rate.
Listing makes a security available for trading, but it cannot promise a buyer. Sparse trading may create liquidity risk and force a seller to accept a lower price. Debt prices can also change as interest rates, remaining tenure, and credit quality move. An early sale may therefore produce a gain or a loss.
Capital Market Instruments
Different securities answer different funding needs. Their rights, payment terms, and risks must be read separately.
Equity Shares
Equity shares give investors a residual ownership claim. Shareholders may vote as permitted and receive declared dividends. Neither payment nor market value is fixed. The dividend payout ratio compares distributed profit with profit retained in the business.
Preference Shares
Issue terms define preference share rights. They generally rank ahead of equity for dividends and capital repayment. Company law limits their voting rights, subject to stated exceptions. An issue may be redeemable or convertible, so holders must check its dates, pricing, and conditions.
Corporate Bonds and Debentures
Bonds and debentures bind a company to written payment terms. Issue papers set the coupon, maturity, redemption, security cover, covenants, and default action. Market value may move before maturity. Rates, credit concerns, tenure, and demand affect the price.
Government Securities
The Union and state governments raise debt through dated securities. The Reserve Bank of India conducts auctions and handles related operations under the government securities framework. Repayment responsibility rests with the issuing government. A holder who sells before maturity can still face a price change caused by interest-rate movement.
Funds and Listed Trusts
Mutual funds combine money from many investors and place it according to a scheme mandate. The portfolio may hold shares, long-term debt, or short-term instruments. Exchange-traded funds can be bought and sold on an exchange. The expense ratio is deducted from scheme assets and reduces the return left for investors. Real Estate Investment Trusts and Infrastructure Investment Trusts raise money by issuing units.
Derivatives
A derivative gets its value from an underlying share, index, interest rate, or another permitted reference. Businesses and investors use these contracts to hedge exposure or take a market position. The contract does not give long-term funding to the underlying issuer. For that reason, it should not be explained as if it were a newly issued share or bond.
Regulations in Capital Market
Companies and governments rely on capital markets for long-term funding. The purpose of capital markets can be served properly only when fundraising and trading follow clear rules. The Securities and Exchange Board of India Act, 1992 establishes the regulator's protection, development, and supervision duties. The Securities Contracts (Regulation) Act, 1956 deals with securities contracts and recognized exchanges. Electronic ownership and transfer are supported by the Depositories Act, 1996.
The Companies Act, 2013 applies when companies issue securities. Public equity offers follow the Securities and Exchange Board of India (Issue of Capital and Disclosure Requirements) Regulations, 2018. Once listed, an entity must follow the Securities and Exchange Board of India (Listing Obligations and Disclosure Requirements) Regulations, 2015. Non-convertible securities have a separate issue and listing framework.
The RBI manages government securities operations under its statutory powers. Foreign investors must meet the eligibility, investment-limit, and foreign-exchange rules for the chosen instrument. Regulation requires disclosure, registration, surveillance, and complaint systems. It can punish misconduct and improve accountability. It cannot guarantee an investor's return or stop prices from falling.
Elements of a Capital Market
The main players of capital markets include issuers, investors, intermediaries, exchanges, depositories, and regulators. Each performs a specific function in raising funds or trading securities.
- Issuers offer securities to raise money under an approved route.
- Investors provide the money and accept the attached rights and risks.
- Intermediaries manage due diligence, applications, broking, trusteeship, custody, and issue records.
- Exchanges and clearing corporations support trading and settlement.
- Depositories keep electronic ownership records, and regulators monitor conduct and compliance.
