Capital Market Meaning, Functions, Importance, Types

Table of Contents:-

  • Meaning of capital market
  • Functions of capital market
  • Importance of capital market
  • Instruments of capital market
  • Role of SEBI in Indian capital market
  • Reforms of the Capital Market Of India
  • Types of Capital Market

Meaning of capital market

The term capital market refers to institutional arrangements that facilitate the lending and borrowing of long-term funds. In the widest sense, it involves a series of channels through which the community’s savings become available for commercial enterprises, industrial, and public authorities. It is concerned with private savings, both individual and corporate, that are converted into investments through new capital issues and also through new public loans floated by semi-government and government bodies. A capital market may be defined as an organized mechanism for the effective and efficient transfer of financial resources or monetary capital from the investing parties, i.e., individuals or institutional savers, to the entrepreneurs (institutions or individuals) engaged in commerce or industry. This business could be in either the public or private sector of an economy.

According to P.K. Dhar, “This is not a market for capital goods; rather it is a market for raising and advancing money capital for investment purposes”

According to M.Y. Khan, “It is a market for long-term funds. Its focus is on the financing of fixed investments in contrast to the money market which is the institutional source of working capital finance”.

Functions of Capital Market

The functions that are performed by the capital market are explained below:

1) Liquidity Function

It provides a means whereby buyers and sellers can exchange securities at mutually satisfactory prices. This improves the liquidity of traded securities.

2) Allocation Function

It allows for the channelization of the savings of innumerable investors to various productive avenues of investments. As a result, the savings for a given period are allocated amongst the various users and uses. The market attracts new investors who are willing to provide funds for businesses. It also allocates and manages funds using a system of penalties and incentives.

3) Other Functions

In addition to the functions of funds allocation and liquidity, the capital market also renders the following functions:

i) Savings and Investment Function: The capital market provides a means of quickly converting long-term investments into liquid funds, thereby generating confidence among investors and speeding up the process of saving and investment.

ii) Merger Function: The capital market encourages voluntary or coercive take-over mechanisms to put the management of inefficient companies into more competent hands.

iii) Indicative Function: A capital market acts as a barometer showing not only the progress of a company but also the economy as a whole through share price movements:

iv) Transfer Function: The capital market facilitates the transfer of existing assets-tangible and intangible-among individual economic units or groups.

Importance of Capital Market

The importance of capital market is explained under the following points:

1) A continuous valuation of companies as reflected in the share price and the implied possibility of merger and takeovers.

2) The stock market attracts foreign investment, which leads to improved accounting, and reporting standards and exposes domestic companies to advanced managerial techniques.

3) The capital market serves as a reliable guide to the performance and financial position of the company.

4) Large, active and liquid stock market induces investors to research and monitor the firms, which leads to improved resource allocation and accelerated growth.

5) The stock market promotes growth through the creation of liquidity.

6) Stock market at times helps companies to obtain equity finance in the absence of loans from the money market.

Instruments of Capital Market

Instruments of capital market are as follows:

1) Sweat Equity

Sweat equity shares are equity shares issued by a company to its employees or directors at a discount, or as a consideration for providing know-how or a similar value to the company.

2) Equity Shares

Equity shares are commonly referred to as ordinary shares or common stock. Even though the words stocks and shares are used interchangeably, there is a difference between them. The share capital of a company is divided into several small units of equal value called shares. The term stock refers to the combined value of a merged into one fund. It’s a collection of shares grouped. The term “stock” is represented in monetary value and not as many shares. Stock can be divided into fractions of any amount and these fractions can be transferred similarly to shares.

3) Preference Share

The characters of the preference stock are hybrid in nature. Some of its features resemble bonds, while others resemble equity shares. Like the bonds, their claims on the company’s income are limited and they receive fixed dividends. In the event of liquidation of the company, their claims on the assets of the firm are also fixed. At the same time, similar to equity, it is a perpetual liability of the corporation. The Board of Directors holds the authority to determine whether or not to distribute dividends to preferred stockholders.  In the case of bonds, payment of interest rate is mandatory.

4) Derivative

A derivative is a financial instrument whose characteristics and value depend upon the characteristics and value of some underlying asset typically a commodity, bond, equity, currency, index, event etc.

5) Debenture

Private sector companies generally issue debentures as a long-term promissory note to raise loan capital. The company promises to pay principal and interest as stipulated. In India, a bond serves as an alternative form of debenture. Financial institutions and public sector companies issue bonds.

6) Warrant

A warrant is a document that grants the holder the right to purchase a specific number of equity shares at a predetermined price. Usually, investors can exercise warrants over several years. The life periods of warrants are long. Issuers generally offer warrants to make the preferred stock or bond offering more attractive to investors.

7) Secured Premium Notes (SPNs)

Issuers release SPN along with a detachable warrant, and investors can redeem it after a notified period, featuring characteristics of medium to long-term notes.

Role of SEBI in Indian capital market

With the expansion of activities in the financial markets, many malpractices are taking place. Practices like false issues, delays in delivery, and violation of rules and regulations of stock exchanges are on the rise. To curb these malpractices, the government of India decided to set up a regulatory body known as the Securities Exchange Board of India (SEBI).

The objectives and roles of SEBI are elaborate and have been described below:

1. SEBI has the power to provide licenses to dealers and brokers of the funds market. If SEBI sees that any financial product is of a capital nature, then SEBI can also control to that product and its dealers.

2. SEBI has the power to make new rules for controlling the stock exchange in India. For example, SEBI fixed the time of trading between 9 AM and 5 PM in the stock market.

3. SEBI has the authority to prevent fraud in the capital market.

  • It can ban brokers involved in fraudulent and unfair trade practices relating to the stock market.
  • It can impose penalties on capital market intermediaries involved in insider trading.

4. SEBI uses its powers to audit the performance of different Indian stock exchanges to bring transparency to the working of stock exchanges.

5. SEBI sees whether this merger or acquisition is for the development of a business or to harm the money market.

6. Ensuring the safety of the investments and Protecting the rights of investors.

7. To develop a code of conduct for intermediaries such as brokers, mutual fund sellers etc.

Reforms of the Capital Market Of India

The Major Reforms undertaken in the capital market of India include:

1. Establishment of SEBI

2. Establishment of Creditors Rating Agencies

3. Increasing of Merchant Banking Activities

4. FII and performance of the Indian Economy

5. Rising Electronic Transactions

6. Growing Mutual Fund Industry

7. Growing Stock Exchanges

8. Investor‟s Protection

9. Growth of Derivative Transactions

10. Insurance Sector Reforms

11. Commodity Trading

Types of Capital Market

The Indian capital market is divided into two broad categories given as follows:

  • Primary Market
  • Secondary Market

Primary and secondary markets compose the structure of capital markets.

Primary markets consist of companies that issue securities known as Initial Public Offerings (IPOs), and investors directly purchase those securities directly from the issuing company. When a company decides to go public, it sells its stocks and bonds to large institutional Investors such as mutual funds and hedge funds. Financial institutions, banks, and high-net-worth individuals (HNIs) are among the primary participants in this market.

Secondary markets are regulated platforms where investors trade previously issued certificates. Regulatory bodies oversee these transactions to ensure fairness and transparency. It is important to note that issuing companies do not participate in the secondary market.

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