If you are a novice at investing, this article on capital market basics is a must-read. The capital market functions as a critical link between savers and investors with entities that need funds like companies, government, and individuals. Existence of capital market is essential for an economy to function, why? We will discuss in detail in the article below.
So, what is a capital market? A capital market is a market for the trading of long-term investments. In other words, it is a marketplace for investments that have a lock-in period greater than a year, or their maturity period is at least more than one year.
The capital market involves the sale and purchase of both equity and debt instruments, including equity shares, debentures, preference shares, secured premium notes, and zero-coupon bonds. It also caters to all forms of lending and borrowing financial transactions.
Let’s learn more about capital markets and explore its functionality. A capital market helps in the mobilisation of savings for financing long-term investments. It also aids in the trading of securities. Also, a capital market reduces transaction and information costs by encouraging the ownership of a broad spectrum of productive financial assets. It facilitates the quick valuation of shares and debentures.
One of the primary functions of a capital market is providing insurance against market volatility and price risk through derivative trading. One of the best things about capital market is also that it offers a wide range of investment instruments to investors, thereby fostering the creation of capital in the economy.
Security transactions in a capital market are undertaken by participants including both individual entities as well as business institutions. As part of capital market basics, let’s cover the types of capital markets. The capital markets are mainly of two types-Primary and Secondary capital markets.
Types of Capital Market
Primary capital market:
In this type of capital market, companies, governments, and public-sector institutions can raise funds through issued bonds. The primary capital market consists of corporations that raise money through the selling of new stocks through an initial public offering (IPO). Therefore, in a primary capital market, investors directly purchase shares from a company. Primary markets are characterised by the trade of new issues of stocks and other securities.
Apart from IPOs, rights issues, private placement shares, and e-IPOs are also issued in the primary market.
When a company wants to raise capital from the market, it turns to its existing investors. current shareholders are given an opportunity or privilege to sign up for more shares from the company, usually at a preferential rate. it is an efficient and quic method to raise funds from the market. some other companies avoid the IPO route because of high incidental costs by placing company shares to selected individual investor. however, these activities also take place in the primary market.
Primary market assist in capital formation, where secondary market is responsible for adding liquidity to the market. together they constitute and ensure functioning of the capital market.
Secondary capital market:
In the secondary capital markets, financial and investment instruments such as stocks, shares, and bonds, among others, are purchased and sold by customers. In a secondary capital market, the chief feature is the exchange and trade of existing or previously-issued securities. Stock exchanges such as the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are examples of secondary capital markets.
Accelerated capital formation, mobilisation of savings, generating long-term capital, the advancement of industrial and economic growth, dynamic channelling of funds, and well-boosted generation of foreign capital are some of the many advantages of capital markets. The existence of the capital market encourages people to invest in productive investment channels, in turn, stimulating industrial and economic development.
Beyond the above classifications, a broad sense of capital market includes a market for any type of financial asset. In a further segregation capital market includes the following sub-categories.
Corporate finance market:
A market where capital fund is available to non-financial companies. instruments traded in the corporate finance market are bonds (public and private) and equities (common and preferred).
It is a marketplace restricted to specific players like investment banks, private equity firms, and venture capital firms.
Public market is open for general investors, brokers, stock exchange – regulated by a governing body.
Capital market performs multiple roles from moving funds for investment, establishing financial instruments evaluation standards, facilitating transaction settlement, and promotes overall economic growth by creating channels for continuous flow of funds.
Now that you are aware of what is a capital market and know the basics, it is time to start investing by carefully analysing capital markets and predicting their future movements.