Capital Market

Chapter 2
FIM
Overview of Capital Market
Any location or system that gives buyers and sellers the ability to
exchange and trade in financial assets, such as bonds, shares, different
international currencies, and derivatives, is referred to as a financial
market. The connection between people with capital to invest and
those who need capital is facilitated by these financial markets. The
Money Market and Capital Market together comprise the financial
market.
Meaning
• A capital market is market for securities (Debt or Equity),where
business enterprises (Companies) and government can raise long
term funds. The primal role of this market is to make investment from
investors who have surplus funds to the ones who are running a
deficit.
• Difference between Capital Market and Money Market
• What is the difference between the capital market and the money
market?
• The main distinction is that capital markets are financial markets
where long-term debt instruments are traded, while money markets
are financial markets where short-term debt instruments are traded.
Capital market instruments have a maturity of over one year, while
money market instruments have a maturity of less than one year.
Functions of Capital Market

• Formation of Capital: There are two types of individuals in the capital markets: investors
who don't need money right away and debtors who do. The capital markets enable
leftover funds to be invested and put to use rather than just hanging around. Therefore,
it gives firms the chance to borrow money and invest in new machinery or other capital
equipment rather than having ₹1 crore sitting in the locker. In exchange, the investor
obtains a dividend and the company has access to more effective machinery. This capital
market role looks at the economy at a macro level.
• Absence of Entry and Exit Barriers: Today's investors generally trade on the capital
markets using their mobile devices, making them more accessible than ever. The spread
of technology has virtually made financial markets accessible to everyone. Investors are
practically prepared to invest as soon as they open an account with a broker. Additionally,
there are now worldwide marketplaces. Due to the increased demand for assets, people
can leave the market just as quickly as they entered.
Economic Growth: The capital market promotes a marketplace for borrowers and lenders,
which results in a more effective flow of cash. Businesses in need of corporate loans can apply
on the capital market, and an underwriter will then issue the loan. As an alternative, it can raise
money by offering a portion of its business on the stock market. Due to the fact that idle capital is
put to use elsewhere in the economy, this promotes economic growth. Simply put, it increases demand.
Businesses that require credit can make investments if they are granted it.
The company that offers the capital equipment that it invested in receives that money in return.
The economy can then continue to grow as a result of that money's circulation.
This aspect is considered to be one of the most important roles of capital market.
Capital Liquidity: People with money can invest it owing to the financial markets.
They receive ownership of a bond or stock in exchange. However, they cannot use a bond certificate to purchase a car,
food, or other assets, thus it could be essential to liquidate them. It is fairly simple for investors to sell their assets to a third
party on the capital markets in exchange for liquid funds (cash).
There is nearly always a buyer if one wishes to sell an item at the current market price, enabling you to convert
the asset into actual cash.
• Price Regulation: Making sure the price of an asset is accurate is one of the
capital markets' primary objectives. A share's price may spike after receiving
favorable news or plunge after reading an unsatisfactory annual report. The
prices fluctuate to the point where the equity worth is represented in its price at
that moment due to the thousands of traders. Bond prices can change and adapt
more quickly as a result of supply and demand at the same time. For instance,
during a recession, investors typically choose bonds since they are perceived as a
safer investment
• Provides Opportunity to Investors: If an investor wants a high level of risk or a
low level of risk, there are enough financial instruments available in the capital
markets to fit their needs. At the same time, capital markets give investors a
chance to increase their capital yield. Savings accounts pay very little interest,
especially when compared to the rates on most equities. Therefore, the capital
market offers investors the chance to earn a higher rate of return, though there is
also some risk involved. This function of capital market stands in the favour of the
investors participating in it.
• What Is a Primary vs. Secondary Market?
• A primary market is raising capital by issuing securities for the first time. In other words,
it's when companies go to banks or investors and ask for money to invest in their
business.
• A secondary market is a process of buying and selling existing securities. So if you hold a
share in a company, you can sell it on the stock exchange to another person who wants
to buy it from you at a price you agree upon (or is set by auction).
• In a primary market, investors buy shares from the company. In a secondary market,
existing shareholders sell their shares to other people.
• The difference between a primary and secondary market can be confusing, especially for
beginners. You might wonder why companies want to raise money by selling existing
shares instead of issuing new ones. But there are good reasons for this. If you've ever
bought or sold stocks, then you know that they can be pretty volatile—the price
fluctuates according to how investors feel about the company at any given time.
• Structure of Capital Market in India
• The structure of the Indian Capital Market can be described by using the
following heads:
• Market: Capital Markets are categorized into two components of capital market:
• Primary Markets: New securities that are originally launched on the stock market are
primarily the focus of the primary market. As a result, the fresh issue market is another name
for it. The primary market's fundamental purpose is to make it easier for businesses to
transfer freshly issued shares to the general public. Financial institutions, banks, HNIs, and
others are the key investors in this sort of market.
• Secondary Markets: The auction market and the dealer market are the two distinct
subcategories of the secondary market. The open outcry mechanism, where buyers and
sellers gather in one place and call out the prices at which they are ready to purchase and sell
their assets, is specific to the auction market. Examples of such capital markets in India
include the National Stock Exchange and the Bombay Stock Exchange. However, in dealer
markets, commerce occurs across electronic networks. The majority of small investors
transact on dealer marketplaces.
Instruments: There are five types of instruments in the capital markets in India:
• Equities: The net difference between a company's total assets and its total
liabilities is known as a company's equity or shareholders' equity. When a
corporation has publicly traded stock, its market capitalization may be
determined by multiplying the share price by the number of outstanding shares.
• Debt Securities: Financial instruments known as debt securities give their owners
the right to receive regular interest payments. Debt securities, in contrast to
equity securities, call on the borrower to pay back the principal amount
borrowed. The perceived creditworthiness of the borrower will have an impact
on the interest rate for a debt instrument.
• Hybrid Securities: A single financial security called hybrid security combines two
or more distinct financial instruments. Often referred to as "hybrids," hybrid
securities typically incorporate both loan and equity features.
• Regulator: The Securities and Exchange Board of India (SEBI) is a
government agency that, among other responsibilities, regulates the
capital markets to protect investors from fraud. Regulation refers to
the actions taken by government-instituted regulatory bodies to
monitor, manage, and oversee capital market processes. It is the only
body that acts as a regulator in the Indian Capital Market.
• Regulators of Capital Market
• The Capital Markets in India are regulated and monitored by the Ministry
of Finance. Therefore, both the major regulators, that is, the Securities and
Exchange Board of India (SEBI) and the Reserve Bank of India (RBI) are
responsible for regulating the capital market.
• The Ministry of Finance regulates the capital market through the
Department of Economic Affairs – Capital Markets Division
• The division is responsible for the following:
• Institutional reforms in the securities markets
• Building regulatory and market institutions
• Strengthening the investor protection mechanism
• Providing an efficient legislative framework for securities markets
• Advantages of Capital Market
• The capital market provides the following advantages for both capital suppliers and
capital seekers:
• Money movement between individuals who need capital and who possess the capital
• Increased efficiency in the transactions
• Securities like shares help in earning dividend income
• Growth in the value of investment increases in the long run
• Interest rates provided by bonds and securities are higher than the banks’ interest rates
• Investors can avail tax benefits by investing in stock markets
• Securities of capital markets can be used as a collateral for availing loans from banks
• Elements of a Capital Market
•
• ● Market sources of funds include individual investors, financial institutions, insurance
companies, commercial banks, businesses, and retirement funds.
• ● Investors invest money intending to make capital gains as their investments grow over time. They also
receive dividends, interest, and ownership rights.
• ● Fund-seekers include companies, entrepreneurs, governments, etc. For example, to fund the economy and
development projects, the government issues bonds and deposits.
• ● These markets usually trade long-term investments such as stocks, bonds, debentures, and government
securities. Moreover, hybrid securities like convertible debentures and preference shares are available.
• ● The market is primarily operated by stock exchanges. Brokerage firms, investment banks, and venture
capitalists are other intermediaries.
• ● The regulatory bodies are responsible for monitoring and eliminating any illegal activities in the capital
market. Securities and Exchange Commission, for example, oversees stock exchange operations
Components of Capital Market: Primary Market and
Secondary Market | Company Management
• 1. Primary Market (New Issue Market):
• Primary market is also known as new issue market. As in this market
securities are sold for the first time, i.e., new securities are issued
from the company. Primary capital market directly contributes in
capital formation because in primary market company goes directly to
investors and utilises these funds for investment in buildings, plants,
machinery etc.
2. Secondary Market (Stock Exchange):

• In secondary market securities are not directly issued by the company

to investors. The securities are sold by existing investors to other
investors. Sometimes the investor is in need of cash and another
investor wants to buy the shares of the company as he could not get
directly from company. Then both the investors can meet in
secondary market and exchange securities for cash through
intermediary called broker.
Method of Floatation of Securities in Primary
Market:
• 1. Public Issue through Prospectus:
• The information in the prospectus helps the public to know about the risk and
earning potential of the company and accordingly they decide whether to invest
or not in that company Through IPO company can approach large number of
persons and can approach public at large. Sometimes companies involve
intermediaries such as bankers, brokers and underwriters to raise capital from
general public.
• 2. Offer for Sale:
• Under this method new securities are offered to general public but not directly by
the company but by an intermediary who buys whole lot of securities from the
company. Generally the intermediaries are the firms of brokers. So sale of
securities takes place in two steps: first when the company issues securities to
the intermediary at face value and second when intermediaries issue securities to
general public at higher price to earn profit. Under this method company is saved
from the formalities and complexities of issuing securities directly to public.
• 3. Private Placement:
• Under this method the securities are sold by the company to an intermediary at a
fixed price and in second step intermediaries sell these securities not to general
public but to selected clients at higher price. The issuing company issues
prospectus to give details about its objectives, future prospects so that reputed
clients prefer to buy the security from intermediary. Under this method the
intermediaries issue securities to selected clients such as UTI, LIC, General
Insurance, etc.
• 4. Right Issue (For Existing Companies):
• This is the issue of new shares to existing shareholders. It is called right issue
because it is the pre-emptive right of shareholders that company must offer them
the new issue before subscribing to outsiders. Each shareholder has the right to
subscribe to the new shares in the proportion of shares he already holds. A right
issue is mandatory for companies under Companies’ Act 1956
Trends in Capital Markets

RegTech Revolution: Regulatory technology (RegTech) has become a

game-changer in capital markets. Through innovative technologies like
artificial intelligence and machine learning, RegTech streamlines
compliance processes, reducing costs and mitigating risks. Automation
of complex regulatory tasks enables market participants to navigate the
ever-changing regulatory landscape efficiently.
IoT Integration: The internet of things (IoT) has extended beyond
consumer devices and made its way into capital markets. IoT devices
collect real-time data from diverse sources, empowering market
participants to make informed investment decisions. IoT’s integration
into capital markets, from supply chain monitoring to asset
performance tracking, enhances transparency and efficiency.
• ESG Considerations: Environmental, social, and governance (ESG) factors
have gained immense importance in capital markets. Investors increasingly
factor in sustainability and ethical practices when making investment
decisions. With the prevalence of ESG reporting standards, market
participants are compelled to align their strategies with responsible
investing principles, long-term value creation, and risk mitigation.
• Emergence of the Crypto Economy: Cryptocurrencies and blockchain
technology have disrupted traditional financial systems. The crypto
economy offers decentralized, transparent, and secure transactions,
attracting investors seeking alternative assets. Capital markets are
exploring ways to incorporate crypto assets, creating new investment
opportunities, and fostering financial inclusivity.
• Data Monetization: The abundance of data in capital markets has led to
the emergence of data monetization strategies. Capital market
organizations leverage data analytics and artificial intelligence to extract
valuable insights, optimize investment strategies, and enhance risk
management. Harnessing the power of data unlocks new revenue streams
and helps to build a competitive edge.
• Composable Enterprise Approach: The composable enterprise emphasizes
modular and interconnected systems, enabling rapid adaptation to
changing market conditions. Capital market organizations embrace
microservices architecture and API-driven ecosystems, seamlessly
integrating diverse applications and services. This agility empowers
companies to respond swiftly to evolving customer needs and capitalize on
emerging opportunities.
Money Market
• Money market consists of various financial institutions and dealers,
who seek to borrow or loan securities. It is the best source to invest
in liquid assets. The money market is an unregulated and informal
market and not structured like the capital markets, where things are
organised in a formal way.
• Objectives of the Money Markets
• The main objectives of the monetary market are as follows,
• The main objective is to provide borrowers with short-term funds at reasonable rates.
And since the securities are all short-term the lenders will also have the benefit of
liquidity.
• Turns savings and idle funds of the public into effective investments. This is beneficial for
the entire economy
• Allows the Reserve Bank of India to regulate the levels of liquidity in the economy. This is
one of the main functions of the RBI.
• Companies and corporations have short-term deficits from time to time. They may also
need help with their working capital requirements. The money market will facilitate the
funds necessary.
• Helps the government implement monetary policies via their open market operations
which are direct and effective in nature.
• Structure of Indian Money Markets
• The Indian monetary market has two broad categories – the organized
sector and the unorganized sector.
• Organized Sector: This sector comprises of the governments, the RBI, the
other commercial banks, rural banks, and even foreign banks. The RBI
organizes and controls this sector. Other corporations like the LIC, UTI, etc
also participate in this sector but not directly. Other large companies and
corporates also participate in this sector through banks.
• Unorganized Sector: These are the indigenous banks and the local money
lenders and hundis etc. Their activities are not controlled by the RBI or any
other body, so they are the unorganized sector.
• Features of Money Market Instruments
• High Liquidity- One of the key features of these financial assets is high
liquidity offered by them. They generate fixed-income for the investor and
short term maturity makes them highly liquid. Owing to this characteristic
money market instruments are considered as close substitutes of money.
• Secure Investment- These financial instruments are one of the most secure
investment avenues available in the market. Since issuers of money market
instruments have a high credit rating and the returns are fixed beforehand,
the risk of losing your invested capital is minuscule.
• Fixed returns- Since money market instruments are offered at a discount to
the face value, the amount that the investor gets on maturity is decided in
advance. This effectively helps individuals in choosing the instrument which
would suit their needs and investment horizon.
Instruments in the Money Market

• Treasury bills- are short term borrowing instruments issued by the Government
of India. These are the oldest money market instruments that are still in use. The
Treasury bill does not pay any interest, but are available at a discount of face
value at the time of issue. Treasury Bills can be classified in two ways i.e. based
on maturity and bases on type. These are the safest instruments as they are
backed by a government guarantee. The rate of return, also known as risk-free
rate, is low for treasury bills like T-364, T-182 and so on, as compared to all other
instruments.
• Commercial papers- commercial papers is an unsecured money market
instruments issued in the form of promissory note. It was introduced In India in
1990 with the objectives of enabling corporate borrowers diversify their sources
of short-term borrowing and to provide an additional investment instrument to
investors. Commercial paper is a money-market security issued (sold) by large
corporations to obtain funds to meet short-term debt obligations and is backed
only by an issuing bank or company’s promise to pay the face value on the
maturity date specified on the note.
• Certificate of Deposit- A certificate of deposit (CD) is issued directly by a
commercial bank, but it can be purchased through brokerage firms. It
comes with a maturity date ranging from three months to five years and
can be issued in any denomination. Most CDs offer a fixed maturity date
and interest rate, and they attract a penalty for withdrawing prior to the
time of maturity. Just like a bank’s checking account, a certificate of deposit
is insured by the Federal Deposit Insurance Corporation (FDIC).
• Banker’s acceptance- a banker’s acceptance is a document that promises
future payment that is guaranteed by the commercial bank. It is considered
to be a very safe investment option and is widely used in foreign trade,
bankers acceptance are time drafts which are accepted and guaranteed by
the banks and drawn on a deposit at the bank. The maturity period of
banker’s acceptance can range from 30 to 180 days.
• Repurchase Agreements- Also known as repos or buybacks,
Repurchase Agreements are a formal agreement between two
parties, where one party sells a security to another, with the promise
of buying it back at a later date from the buyer. It is also called a Sell-
Buy transaction. The seller buys the security at a predetermined time
and amount which also includes the interest rate at which the buyer
agreed to buy the security.
• Function of money market
• Provides funds– the money market provides short term funds for
borrowing at a lower rate of interest. The private and the public institutions
can borrow money from the money market to finance capital requirements
and fund business growth through the system of finance bills and
commercial paper. The govt. can also borrow funds the money market by
issuing treasury bills. However, money market issues money market
instruments like commercial papers, treasury bills and so on and helps in
development of trade, industry and commerce within and outside India.
• Central Bank Policies- The central bank is responsible for guiding the
monetary policy of a country and taking measures to ensure a healthy
financial system. Through the money market, the central bank can perform
its policy-making function efficiently.
• Helps government- the money market instruments helps the
government raise money for financing government projects for public
welfare and infrastructure development. The govt. can borrow short
term funds by issuing treasury bills at low interest rates. On the other
hand, if the government were ton issue paper money or borrow short
term funds by issuing treasury bills at low interest rates. On the other
hand, if the govt. were to issue paper money or borrow from the
central bank, it would lead to inflation in the economy.
• Helps in Financial Mobility- the money market helps in financial
mobility by enabling easy transfer of funds from one sector to the
other. Financial mobility is essential for the development of industry
and commerce in the economy
• Promote Liquidity and Safety- this is one of the most important
functions of money market, as it provides safety and liquidity of
funds. It also encourages saving and investments. These investments
instruments have shorter maturity which means they can readily be
converted to cash. The money market instruments are issues by
entities with good credit score which a=makes them safe investment
option.
• Economy in use of cash- as the money market deals in near-money
assets and not proper money; it helps in economizing the use of cash.
It provides a convenient and safe way of transferring funds from one
place to another, there by immensely helps commerce and industry in
India.
• Importance/Advantages and Disadvantages of Money Markets
• Advantages:
• Liquidity: Money market instruments are highly liquid, meaning they can be easily bought or sold with
minimal impact on market value. This allows investors to access their funds quickly, providing flexibility and
ease of cash management.
• Safety: Money market instruments are generally considered low risk. They frequently come from
respectable institutions like governments and reputable businesses, which lowers the risk of default. This
makes money market investments a relatively safe option for preserving capital.
• Stable Returns: Money market instruments offer stable and predictable returns. They typically provide
interest payments or discounts at maturity, allowing investors to earn a modest return on their investments.
This makes money market investments suitable for those seeking stability and capital preservation.
• Diversification: Money market instruments provide an opportunity for portfolio diversification. Investing in
various money market instruments with varying maturities and issuers can spread their risk and reduce
exposure to any single entity or maturity date.
• Short-Term Financing: For borrowers, money markets offer a convenient and efficient source of short-term
financing. Governments, corporations, and financial institutions can issue money market instruments to
raise funds quickly and meet their immediate cash flow needs. This enables them to bridge temporary
funding gaps and manage liquidity effectively.
• Disadvantages:
• Lower Returns: While money market investments offer stability, they generally provide lower returns than other investment
options, such as stocks or long-term bonds. The conservative nature of money market instruments translates to a lower potential
for significant capital appreciation or high yields.
• Inflation Risk: Money market investments may be susceptible to inflation risk. If the interest rates on money market instruments
fail to keep pace with inflation, the real value of the investment can erode over time. This can impact the purchasing power of the
investor’s funds.
• Limited Growth Potential: Money market investments may not provide significant opportunities for capital growth. These
instruments primarily focus on capital preservation and short-term liquidity management, making them less suitable for investors
seeking substantial growth or long-term wealth accumulation.
• Regulatory Changes: Money market investments can be subject to regulatory changes, which may impact their performance and
liquidity. Changes in regulations governing money market funds or the issuers of money market instruments can introduce
uncertainties and affect the attractiveness of these investments.
• Market Conditions: Current market conditions, such as interest rate fluctuations and market volatility, can have an impact on
money market investments. Changes in interest rates can affect the yields on money market instruments, potentially impacting
returns for investors.
• Limited Investment Options: Money markets provide a narrower range of investment options than broader financial markets.
Investors looking for more diverse investment opportunities or higher potential returns may need to explore other financial
market segments.
Recent Trends money market

• Growth of Digital Finance

• There has been an exponential increase in digital finance in India over
recent years. This is further backed by various measures under the ‘Digital
India’ vision of the government. This includes digital payment methods
such as UPI, mobile banking, and e-wallets. This growth is also the result of
the increase in internet and smartphone penetration which has taken
digital finance to even the rural parts of the country.
• Focus on Financial Inclusion
• Financial inclusion has been the focus of the Indian government and
regulators for many years now. Many measures for financial inclusion
include increasing access to financial services for under-served populations
such as farmers and small businesses.
• Rise of Mutual Funds
• Mutual funds have become increasingly popular and a staple among retail
investors as a way to invest in the stock market. The introduction of direct plans
has also made them more accessible and cost-effective for the average investor.
• Increased Focus on ESG Investing
• Social consciousness has been increasing greatly among the public at large over
the years. This has therefore resulted in an increase in Environmental, Social, and
Governance (ESG) investing which is gaining prominence as investors increasingly
seek to align their investments with their values.
• Emergence of Robo-Advisors
• Financial markets have also seen a rise in Robo-advisors. These are algorithms
that provide investment advice based on AI. Such platforms are becoming quite
popular by offering low-cost and personalized investment solutions to businesses
and investors.