What is Capital Market?
Capital Market is a place where buyers and sellers can interact and transact financial securities like shares, debentures, debt instruments, bonds, derivative instruments like the futures, options, swaps, ETFs.
- The securities referred to here would normally mean long-term investments, i.e. investments that have a lock-in period greater than one year.
- Trading of short-term investments is done through money-market, rather than the capital market.
What are the Functions of Capital Market?
- It makes trading of securities easier for investors and companies.
- It assists the transaction settlement in time.
- It helps minimize transaction costs and information costs.
- It mobilizes the savings of parties from cash and other forms to financial markets.
- It offers insurance against market risk.
Types of Capital Market
Let us discuss each type of capital market in detail:
#1 – Primary Market
The primary market is a market where freshly issued securities are traded i.e. for the first time. It is also known as the new issues market. This market enables both initial public offering and a further public offering. In this market, the funds will be deployed with the help of offering through a prospectus, preferential issue, rights issue, e-IPO, and private placement of securities.
#2 – Secondary Market
It is a type of capital market where old securities are traded i.e. trading done after transacting first in the primary market. We also call this market as the stock market or aftermarket. Both stock markets and over-the-counter trades come under the secondary market. Examples of secondary markets are the London Stock Exchange, the New York Stock Exchange, NASDAQ, etc.
Advantages of Capital Market
Some of the advantages are as follows:
- It improves the efficiency of transactions.
- They move money between the investors, i.e., people who supply capital and people in need of capital.
- Secondary markets create liquidity in the market.
- Securities like bonds pay interest to the investors, and most of the time, the interest so paid is higher than the bank interest rates.
- Securities like shares pay dividend income.
- There is a greater scope for growth of the value of investments as time passes.
- Instruments of capital market possess liquidity i.e. we can convert them into cash and cash equivalents when there is a need for funds immediately with lower transactional costs.
- Investment in shares provides investors with ownership rights, which allows them to have a say in the company’s management decision.
- It promotes diversification by offering a wide range of investment types.
- Usually, the securities of the capital market can be used as collateral for getting loans from banks and financial institutions.
- There would be a few tax benefits that accrue whilst investing in the stock market.
- Holding on to a few securities may ensure superior long-term performance.
Disadvantages of Capital Market
Some disadvantages of the capital market are:
- Investing in the capital market is deemed to be very risky as the investment is highly volatile when it comes to the value i.e. the instruments of a capital market are subject to the market ups and downs.
- Such fluctuations make these kinds of investments unsuitable to provide a fixed income, especially retired employees who would usually prefer regular income.
- With the wide range of investment alternatives present in the capital market, an investor may not be able to decide what kind of investments to pursue thus making it difficult for an investor to invest without a piece of professional advice.
- If an investor invests in shares of a company, he would be considered having ownership rights. This may, prima facie sound like an advantage but, this means that the investor being the owner of the company would be the last party to receive any proceeds in case the company goes into liquidation or becomes bankrupt.
- Buying and selling of securities may involve a brokerage fee, commission, etc. increasing the cost of transactions.
- Capital markets deal with long-term loans and debts, shares, debentures, bonds, government securities, etc.
- It operates with the help of stock exchanges predominantly.
- They encourage investors to invest in its instruments by offering incentives like divided, interest, which leads to capital formation.
- They are known for mobilizing savings from banks, financial institutions, real estate, and gold, thus diverting savings from unproductive channels to productive areas.
- The investors in the capital markets having funds are called the surplus units and the ones borrowing the funds are called deficit units.
- The funds move from the surplus units to the deficit units.
- They help in proper regulation of funds and liquidity creation.
- Commercial Bank, financial institutions, insurance companies, business corporations, and retirement funds are the major suppliers of funds in the capital markets.
It is a market where buyers and sellers interact and transact. Though it performs functions similar to the money market, it is different in the sense that it deals usually with long-term securities. It is an organized and well-regulated market and has the power to move savings from a less productive means to a route where there is a need for capital and where capital is also rewarded. Though it may be very risky in terms of providing significant fixed returns periodically, it is very much preferred because of the anticipation of a long term propitious performance.
This has been a guide to the capital market and its meaning. Here we discuss its functions, types of the capital market along with advantages and disadvantages. You can learn more about financing from the following articles –