Capital Market Instruments

• The financial system plays the key role in the economy by stimulating economic
growth, influencing economic performance of the actors, affecting economic welfare.

• This is achieved by financial infrastructure, in which entities with funds allocate those
funds to those who have potentially more productive ways to invest those funds.

• The financial system of an economy consists of three main components:

1) Financial markets;

2) Financial intermediaries (institutions);

3) Financial regulators.

Financial Market:

• A financial market is a market where financial instruments are exchanged or traded.

• Financial market is a market which facilitates creation of assets and exchange of

securities to provide short-, medium- and long-term business finance.

• It mobilizes funds between savers and investors.

• It locates funds into the most productive investment opportunities.

Characteristics of Financial Markets

 Large Volume of transactions

 Various Segments

 Instant arbitrage

 Volatility

 Dominated by financial intermediaries

 Integrated with worldwide financial markets

There are two types of Financial Markets:

 Money Market

 Capital Market
• Money Market: It is a market which deals in short term securities and whose
maturity period is less than one year.

• The money market is a market for short-term funds, which deals in financial assets
whose period of maturity is up to one year.

• It should be noted that money market does not deal in cash or money as such but
simply provides a market for credit instruments such as bills of exchange, promissory
notes, commercial paper, treasury bills, etc.

• The Indian money market (main players) consists of Reserve Bank of India,
Commercial banks, Co-operative banks, LIC, and other specialized financial
institutions.

• The Reserve Bank of India is the leader/controller of the money market in India.

Characteristics:

 Short term debt instruments

 Highly liquidity

 Low risk

 Fulfill short term needs

 Controlled by RBI

Money Market Instruments

• Treasury Bills: A treasury bill is a promissory note issued by the RBI to meet the
short-term requirement of funds. Treasury bills are highly liquid instruments that
mean, at any time the holder of treasury bills can transfer of or get it discounted from
RBI. These bills are secured instruments and are issued for a period of not exceeding
364 days. Banks, Financial institutions and corporations normally play major role in
the treasury bill market.

• Commercial Papers: Commercial paper (CP) is a popular instrument for financing

working capital requirements of companies. The CP is an unsecured instrument issued
in the form of promissory note. It can be issued for period ranging from 15 days to
 one year. Commercial papers are transferable by endorsement and delivery. The
highly reputed companies (Blue Chip companies) are the major player of commercial
paper market. The major issuers of commercial papers are financial institutions, such
as finance companies, bank holding companies and insurance companies.

• Certificate of Deposit: These are short-term instruments issued by Commercial

Banks and Special Financial Institutions (SFIs), which are freely transferable from
one party to another. The maturity period of CDs ranges from 91 days to one year.
These can be issued to individuals, co-operatives and companies.

• Commercial Bills: Normally the traders buy goods from the wholesalers or
manufactures on credit. The sellers get payment after the end of the credit period. This
trade bill can now be discounted with a bank before its maturity.

Capital Market:

• Capital Market may be defined as a market dealing in medium and long term funds.

• It is a market which deals in medium and long term securities with a maturity period
of more than one year.

• Capital markets are financial markets where people trade stocks, bonds and other
assets.
• The capital market is the sector of the financial market where long-term financial
instruments issued by corporations and governments trade

• It is an institutional arrangement for borrowing medium and long-term funds and

which provides facilities for marketing and trading of securities.

• It constitutes all long-term borrowings from banks and financial institutions,

borrowings from foreign markets and raising of capital by issue various securities
such as shares debentures, bonds, etc.

• The Capital Market comprises the complex of institutions and mechanisms through
which intermediate term funds and long-term funds are pooled and made available to
business, government and individuals.

Functions of Capital market:

 Links borrowers and investors

 Mobilization of Savings

 Capital Formation

 Provision of Investment Avenue

 Speed up Economic Growth and Development

 Proper Regulation of Funds

 Continuous Availability of Funds

How does a Capital Market work?

• In capital market, the primary mechanism (primary market) through which funds
are raised is the issuance of financial instruments by the entities seeking capital.

• The primary market where securities like stocks and bonds are introduced to the
public for the first time.

• An Initial Public Offering (IPO) is a common method , where companies go to public

and raise capital by selling shares to investors.
• Alternatively, debt instruments like bonds represent a way for entities to borrow
money from investors with the promise interest payments and the return of principal
at maturity.

• Once these financial instruments are issued, they enter the secondary market. Here,
investors trade them among themselves without involvement from the issuing entity.
The secondary market is where the familiar image of stock exchanges comes into
play, as investors buy and sell securities on platforms like the National Stock
Exchange or the Bombay Stock Exchange.

• The prices of these securities are determined by the interplay of supply and demand.
If more investors want to buy a particular security (demand) than sell it
(Supply), its price tends to rise. Conversely, if more investors want to sell than
buy, the price tends to fall.

• Intermediaries such as brokers, investment banks and other financial institutions

facilitate the smooth functioning of capital markets. They connect buyers and sellers,
provide research and analysis, and assist in the issuance and trading of securities.

• Regulatory bodies like the Securities and Exchange Board of India (SEBI) oversee
and enforce rules to maintain fair, transparent, and orderly, markets.

Characteristics of Capital Market

• Bring together investors and sellers.

• The three main participants of the capital markets are savers (also known as
investors), borrowers, and stockholders.

• Brokers and dealers play an important role

• Competition among the market players is a key factor

• Transfer of ownership of securities

Different Instruments of the Capital Market

• Equity Security:

1. Equity Shares: These shares are the prime source of finance for a public
limited or joint-stock company. When individuals or institutions purchase
 them, shareholders have the right to vote and also benefit from dividends
when such an organization makes profits. Shareholders, in such cases, are
regarded as the owners of a company since they hold its shares.

2. Preference Shares: These are the secondary sources of finance for a public
limited company. As the name suggests, holders of such shares enjoy
exclusive rights or preferential treatment by that company in specific aspects.
They are likely to receive their dividend before equity shareholders. However,
they do not typically have any voting rights.

3. . Debt Security: It is a fixed income instrument, primarily issued by supreme

and state governments, municipalities, and even companies to finance
infrastructural development and other types of projects. It can be viewed as a
loan instrument, where a bond’s issuer is the borrower.

4. Bonds: Bondholders are considered as creditors concerning such an entity and

are entitled to periodic interest payment. The issuers of bonds are mandated to
repay the principal amount on the maturity date to bondholders.

5. Debentures: Unlike bonds, debentures are unsecured investment options.

Here, lending is entirely based on mutual trust, and, herein, investors act as
potential creditors of an issuing institution or company.

Types of Capital Market:

There are two types of capital market

• Primary market: Primary market deals with the securities which are issued for the
first time in the market and is also known as new issues market. Banks, financial
institutions, insurance companies, mutual funds and individuals are the main
participants in the primary market.

• Herein, the trading takes place for new securities. Companies go public for the first
time in this market allows investors to purchase their shares. This phenomenon is
called Initial Public Offering or IPO.

• A rights offering (issue) permits companies to raise additional equity through the
primary market after already having securities enter the secondary market.
 • Other types of primary market offerings for stocks include private placement and
preferential allotment.

Secondary markets:

• A secondary market is a platform wherein the shares of companies are traded among
investors. It means that investors can freely buy and sell shares without the
intervention of the issuing company.

• It deals with securities that have already been traded in the primary market. New York
Stock Exchange (NYSE), Bombay Stock Exchange (BSE), National Stock Exchange
(NSE), etc. are secondary markets.

Types of a secondary market:

 Over the Counter (OTC) markets: An over-the-counter (OTC) market is a

decentralized market (they don't have a firm physical location) in which
market participants trade stocks, commodities, currencies, or other instruments
directly between two parties and without a central exchange or broker.

• It refers to anything that is bought and sold directly between seller and buyer,
away from the formal securities exchange.

• The trading is carried out directly either by computer, email, or over the
telephone.

• An OTC stock is one that is not listed on an exchange, such as a stock market.

• OTC derivatives are traded privately and bilaterally (2 parties) and not on a
formal exchange platform.

Foreign exchange market (FOREX), foreign currency, ADRs, and new issues are an example
of an over-the-counter market. In such markets, there is a lot of inherent competition present
and hence there are no standard rates for a particular commodity, different rates would be
offered by different retailers to a consumer.

Apart from the stock exchange and OTC market, other types of secondary market include
auction market and dealer market.

OTC and Stock Market

• Decentralised market

• Small Companies

• No Physical location

• 24/7 trading hours

• Unlisted stocks

• Low transparency

• Organised and regulated market

• Well established companies

• There is a physical location

• Exchange Hours

• Listed stocks

• High transparency

Securities:

• The term "security" is defined broadly to include a wide array of investments, such as
stocks, bonds, notes, debentures, limited partnership interests, and investment
contracts.

• A security is a financial instrument, typically any financial asset that can be traded.

• Securities are tradable financial instruments used to raise capital in public and private
markets.

• There are primarily three types of securities: equity—which provides ownership rights
to holders; debt—essentially loans repaid with periodic payments; and hybrids—
which combine aspects of debt and equity.

Types of Securities

1. Equity securities – which includes stocks

 2. Debt securities – which includes bonds and banknotes

3. Derivatives – which includes options and futures

Securities and Exchange Board of India (SEBI)

• The Securities and Exchange Board of India was constituted as a non-statutory body
on April 12, 1988 through a resolution of the Government of India.

• The Securities and Exchange Board of India was established as a statutory body in the
year 1992 and the provisions of the Securities and Exchange Board of India Act, 1992
and came into force on January 30, 1992.

• Its headquarter is located in Mumbai, and regional offices in New Delhi, Kolkata,
Chennai and Ahmedabad.

• It is also known as the prime regulator of the Indian stock market.

• It works under the ownership of the Ministry of Finance, Government of India.

• The Securities and Exchange Board of India’s primary responsibility is to safeguard

the interests of investors in securities and to promote and regulate the securities
market.

• It ensures fair and efficient practices in the securities market.

• Ms. Madhabi Puri Buch has been the Chairman of SEBI as of 2024.

Members of SEBI:

i. A chairman, nominated by the union government of India;

ii. Two members, Officers from union finance ministry;

iii. One member from the Reserve Bank Of India;

iv. Five members, nominated by the union government of India, three out of them shall
be full-time members.

Objectives of SEBI:

• Protecting the interests of all the investors in the securities market and providing a
healthy environment to them.

• Working for the regulation of the securities market by preventing any malpractices.
 • Promoting the development of the securities market with proper and fair functioning
by checking over brokers, underwriters, etc.

• fair and efficient practices in the securities market

Functions of SEBI

The functioning of the Securities Exchange Board of India is primarily divided into the
following three categories:

1. Protective Function

2. Regulatory Function

3. Development Function

Protective Functions

1. Preventing insider trading

2. Creating awareness among investors

3. Promoting fair practices

4. Prohibiting unfair trade practices

Regulatory Functions

5. Performing and exercising powers

6. Conducting inquiries and audit of exchanges

7. Levying of fees

8. Regulating takeover of companies

9. Registering and regulating credit rating agencies

Development Functions

10. Carrying out research and development work

11. Promoting of fair-trading practices

12. Reducing malpractices within the securities market

13. Imparting training to intermediaries

 Powers of SEBI:

 SEBI has powers relating to stock exchanges and intermediaries i.e. It can ask about
information regarding business transactions for inspection or scrutiny and other
purposes.

 To impose monetary penalties on capital market intermediaries. It can also impose a

suspension of their registration for a small period.

 It has the power to initiate actions into functions assigned.

 Has the power to regulate insider trading.

 It has the power to regulate the business of the stock exchange.

National Stock Exchange (NSE):

• The National Stock Exchange of India (NSE) is India's largest financial market. NSE
was the first exchange in India to implement electronic or screen-based trading which
began its operations in 1994.

• It serves as a platform for buying or selling various financial instruments including

equities, derivatives, currencies and debt securities.

• The NSE was founded as a result of the recommendation made by the Pherwani
Committee in 1992. the committee was established to examine the feasibility of
establishing a modern and technologically advanced stock exchange in India.

• The benchmark index NSE in India is the Nifty 50. It comprises 50 well established
and liquid stocks from different sectors.

• There are 2,266 companies listed on the NSE.

• Nifty 50 – 22,396.60 (23rd April, 2024)

Major Indices in National Stock Exchange

• Nifty 100 index

 • Nifty Next 50 index

• Nifty 50 Midcap index

• Nifty Small cap 250 index

• India Vix index

Bombay Stock Exchange:

• It is an Indian stock exchange which is located on Dalal Street, known as the Wall
Street of Mumbai.

• it is the oldest stock exchange in Asia.

• The BSE's overall performance is measured by the Sensex, a benchmark index of 30

of the BSE's largest and most actively traded stocks covering a broad range of
sectors.

• Also called the "BSE 30," the index broadly represents the composition of India's
entire market.

There are a total of 5,309 listed companies on BSE.

• Sensex is calculated on the top 30 large-cap company stocks trading in BSE.

• It is the benchmark index of the BSE in India.

• BSE Sensex 73, 880.39 (23rd April, 2024).

Top Indices in BSE:

• S&P BSE 100

• S&P BSE Mid-Cap

• S&P BSE Sensex

• S&P BSE Small-Cap

Bull market (Bullish market) is when stock prices are on the rise and economically sound,
while a bear market (Bearish market) is when prices are in decline.

Why Do Companies List on Stock Exchanges?

• Get Funds For Business Expansion or Debt Consolidation

• Reputation

• Safe Transactions

• BSE facilitates trading in various categories, such as equity, futures & options, and
fixed income instruments.

Listed Companies:

• Listed companies are public companies whose shares are listed on a recognized stock
exchange for public trading.

• Listing is the process of taking a privately-owned organisation and making the

transition to a publicly- owned entity whose shares can be traded on a stock exchange.

• A few examples of listed companies in India are Reliance Industries Limited, Tata
Consultancy Services, HDFC Bank, Infosys Limited, Bharti Airtel Limited, etc. The
stocks of these companies are listed on the Bombay Stock Exchange (BSE) or
National Stock Exchange

• A listed company is a stock exchange-listed company wherein the shares are openly
tradable. An unlisted company is a company that is not listed on the stock market.

• There are 23 stock exchanges in India. Example: BSE Ltd., Calcutta Stock Exchange
Ltd., Indian Commodity Exchange Ltd., Bangalore Stock Exchange Ltd. Etc.

Steps in trading and settlement procedure:

 Selection of broker

 Opening Demat Account

 Placing the order

 Executing the order

 Settlement

Over the Counter Exchange of India (OTCEI):

• It is the counter market where buyers and sellers seek each other to purchase/sell
securities of small and medium companies as per terms and conditions. OTCEI was
incorporated in 1992 under the Companies Act, 1956.

Benefits:

• Trading platform to small companies.

• Cost effective method for businesses.
• Trade in both primary and secondary markets.
• Gives freedom of choice to investors.
• Transparent system of trading.
• Free flow of information

Constituents of Indian Capital Market:

1. The guilt-edged market (Government Securities market): It is the market for

government and semi-government securities.
• The term gilt describes a bond with a low risk of default and a low rate of return.

• The return on investments in these securities is guaranteed.

• The market is dominated by institutions like LIC, Provident fund and the commercial
banks.

2. Industrial Securities Market: This is the market for corporate securities such as
equities, bonds and debentures. It comprises of primary market (Public issue, Rights
issue, private Placement) and secondary market (OTC, Stock Exchange).
3. Derivatives Market: It is fast emerging as an integral part of capital market. The
market can be divided into two, that for exchange-traded derivatives and that for over-
the-counter derivatives. Derivatives are financial contracts, and their value is
determined by the value of an underlying asset or set of assets. Stocks, bonds,
currencies, commodities, and market indices are all common assets. The underlying
assets' value fluctuates in response to market conditions. Ex: Forward, Future,
Options, Swaps etc.
 Stocks:

• A stock is a general term used to describe the ownership certificates of any company.

• A share, on the other hand, refers to the stock certificate of a particular company.

• stock is a share in the ownership of a company.

Instruments Traded in the Capital Market in India

• Equities: It refer to the money invested in an organization by purchasing shares in the

stock market.

Equity Shares: Equity shares/Ordinary shares are part ownership where the
shareholders are owners and initiate the maximum entrepreneurial liability related to a
trading concern. Equity shareholders reserve the right to vote. However, holders of this
instrument rank bottom on the scale of preference in the event of company liquidation
because they are considered owners of the enterprise.

Features:

• Equity shares are permanent in nature.

• Equity shares have the potential to generate significant returns to the shareholders.
However, these are risky investment options.

• Share of dividend depend upon profits.

• Most equity shareholders have voting rights.

• Equity shareholders are eligible for additional profits a company makes.

• Limited liability

Types of Equity Share:

• Authorized Share Capital- This amount is the highest amount an organization can
issue. This amount can be changed time as per the companies recommendation and
with the help of few formalities.

• Issued Share Capital- This is the approved capital which an organization gives to the
investors.
 • Subscribed Share Capital- This is a portion of the issued capital which an investor
accepts and agrees upon.

• Paid Up Capital- This is a section of the subscribed capital, that the investors give.
Paid-up capital is the money that an organization really invests in the company’s
operation.

• Right Share- These are those type of share that an organization issue to their existing
stockholders. This type of share is issued by the company to preserve the proprietary
rights of old investors.

• Bonus Share- When a business split the stock to its stockholders in the dividend
form, we call it a bonus share.

• Sweat Equity Share- This type of share is allocated only to the outstanding workers
or executives of an organization for their excellent work on providing intellectual
property rights to an organization.

Preference Shares: Preference shares are issued by corporate bodies, and on the scale of
preference, the investors rank second when the company goes under. These shares are often
treated as debt instruments as they do not have voting rights to the holders. They also have a
dividend payment structured like a coupon or interest paid for bond issues. The following are
the features of preference shares.

• Preference shares allow owners to receive dividend distributions

• No Voting Rights

• It can be converted to a common stock

Types of Preference Shares:

1. Convertible Preference Shares: Convertible preference shares can readily be converted

into equity shares.

2. Non-Convertible Preference Shares: Non-convertible preference shares cannot be

converted into common shares.

3. Redeemable Preference Shares: You can redeem or repurchase this preference share type
from the issuing company at a specified price and date. This stock benefits the company by
serving as a buffer against inflation.
4. Non-Redeemable Preference Shares: Non-redeemable preference shares are
advantageous for companies because they act as lifelines against inflation. You cannot
repurchase these shares from the issuing company at a specified date.

5. Participating Preference Shares: These shares enable shareholders to claim a portion of

the company's excess earnings after dividends are paid to other shareholders at the time of
liquidation. However, these shareholders receive a fixed dividend and participate in the
company's surplus with the holders of the shares.

6. Non-Participating Preference Shares: These shares do not offer the owners the
opportunity to receive dividends from the company's surplus profits, but they do receive fixed
dividends from the company.

7. Cumulative Preference Shares: Cumulative preference shares give owners the right to
receive cumulative dividends from the company, even if it is not profitable. These dividends
are arrears in years when the company is not profitable and are paid in full in the following
year when the company is profitable.

8. Non-Cumulative Preference Shares: In the case of non-cumulative preference shares,

investors cannot collect dividends in the form of arrears. Dividends are paid out of the
company's profits for the current year. Therefore, if a company does not profit in a year,
shareholders will not receive a dividend for that year, nor can they receive dividends on
future profits or years.

9. Adjustable Preference Shares: The dividend rate for adjustable preference shares is not
fixed and changes as per current market rates.

Stock valuation

• It is a method of determining the intrinsic value (or theoretical value) of a stock.

• Stock valuation is an important tool that can help you make informed decisions about
trading using a share market app.

• It is a technique that determines the value of a company's stock by using standard

formulas. It values the fair market value of a financial instrument at a particular
time.
 • it means to calculate the fair market value or intrinsic value of stock by using some
technique or model.
• Stock valuation is the process of determining the intrinsic value of a company's stock.
This value assists investors and financial analysts in making decisions to buy, sell, or
hold the stock.

• The reason for stock valuation is to predict the future price or potential market prices
for the investors to time their sales or purchase of investments.

• Intrinsic value is an estimate of a stock’s “fair” value (how much a stock should be
worth)

• Market price is the actual price of a stock, which is determined by the demand and
supply of the stock in the market.

Stock valuation is usually divided into two groups:

• Absolute Valuation.

• Relative Valuation.

Absolute Valuation:

• Absolute valuation intends to find the intrinsic value of the financial instrument. This
method only focuses on the fundamental strengths of the company as the dividends,
cash flow, and the growth rate for a single company. The methods used under
Absolute Valuation are:

a. Dividend Discount Model (DDM): It calculates the true value of the company by
assessing its dividend payout to its shareholders. According to this method, the
dividend is the representation of the actual cash flow of the company. It shows the
true value of the company's share.
b. Discounted Cash Flow model (DCF):This method is suitable for companies that do
not make regular dividend payments to its shareholders. The method uses the
discounted future cash flow of the company to calculate its market value. The method
is applicable for companies that pay a dividend or do not pay a dividend to their
shareholders.
c. Comparable method: The Comparable method does not use any kind of parameters
to find the market value. Instead, it compares the stock price multiples to a set
 benchmark value. The rationale for this method is that the similar financial
instruments carry the same market value.

2. Methods used under Relative Valuation: Relative Valuation method uses ratio and
other types of valuation methods to ascertain the value of the stock. The common
ratios used are:
• Price per earning
• Earnings per share
• Growth rate
• Price-earnings-to-growth ratio
• Sum of Perpetuities method
• Return on assets
• Enterprise value
• Market capitalization
Enterprise value-to-sales ratio