Capital Market, Definition, Types, Functions, Examples

Capital Market, Definition, Types, Functions, Examples, Instruments

Capital Markets are where savings and investments are channelled between suppliers and those in need. Read all about Capital Market, Types, Examples, Instruments & its Functions here for theUPSC exam.

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Capital Market

The capital market is a segment of the financial market where long-term securities such as stocks, bonds, and other financial instruments are bought and sold. It provides a platform for raising capital for businesses and governments and allows investors to invest in these securities to earn returns. The capital market plays a vital role in channelling funds from savers to borrowers and facilitating long-term investments in the economy.

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Types of Capital Market

Here are different types of Capital Markets and their examples:

Type of Capital Market	Description	Examples
Equity Market	Market for buying and selling shares of ownership in companies	National Stock Exchange (NSE), Bombay Stock Exchange (BSE)
Debt Market	Market for buying and selling debt instruments	Government Bonds, Corporate Bonds, Debentures
Money Market	Market for short-term borrowing and lending	Treasury Bills, Commercial Paper, Certificates of Deposit
Foreign Exchange Market	Market for buying and selling currencies	Interbank Foreign Exchange Market, Forex Exchange Market
Derivatives Market	Market for trading derivative contracts	Futures, Options, Swaps
Commodities Market	Market for buying and selling commodities	Multi Commodity Exchange (MCX), National Commodity and Derivatives Exchange (NCDEX)
Mortgage Market	Market for buying and selling mortgage-backed securities	Secondary Mortgage Market, Mortgage-Backed Securities (MBS)
Primary Market	Market for issuing and buying newly issued securities	Initial Public Offerings (IPOs), Rights Issues, Private Placements
Secondary Market	Market for buying and selling existing securities	Stock Exchanges, Over-the-Counter (OTC) Markets

These different types of capital markets provide avenues for investors to participate in various financial instruments, trade securities, and access different sectors of the economy.

Read about: Broad Money and Narrow Money

Capital Market in India

The capital market in India refers to the segment of the financial market that deals with long-term securities such as stocks and bonds. Here are details about the structure and related history of the capital market in India:

Structure of Capital Market in India

Primary Market

The primary market in India is where new securities are issued and offered to the public for the first time. It includes Initial Public Offerings (IPOs) by companies, rights issues, and private placements. The Securities and Exchange Board of India (SEBI) regulates and oversees the primary market.

Secondary Market

The secondary market is where already issued securities are bought and sold among investors. It consists of stock exchanges, such as the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE), where equity shares, bonds, and other securities are traded. SEBI regulates and supervises the secondary market as well.

Stock Exchanges

The National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) are the two major stock exchanges in India. They provide electronic trading platforms where investors can buy and sell securities. These exchanges play a crucial role in price discovery, liquidity provision, and facilitating fair and transparent trading.

Securities Depositories

In India, there are two central securities depositories, namely the National Securities Depository Limited (NSDL) and the Central Depository Services Limited (CDSL). They facilitate the electronic holding and settlement of securities, eliminating the need for physical certificates.

Regulatory Authorities

The capital market in India is regulated by SEBI, which oversees the functioning of stock exchanges, brokers, investment banks, and other market intermediaries. SEBI formulates regulations, monitors market activities, and ensures investor protection and market integrity.

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History of Capital Market in India

The capital market in India has evolved significantly over the years. Here are some key milestones:

The Bombay Stock Exchange (BSE) was established in 1875 as the first stock exchange in India. It started as an association of stockbrokers and gradually grew to become one of the largest stock exchanges in Asia.
The Securities and Exchange Board of India (SEBI) was established in 1988 as the regulatory body for the securities market. It was given statutory powers in 1992 to regulate and develop the capital market.
The National Stock Exchange (NSE) was established in 1992 as a technology-driven stock exchange to provide transparent and efficient trading. It introduced electronic trading systems and innovative products, revolutionizing the Indian capital market.
The introduction of the Depository Act in 1996 led to the establishment of NSDL and CDSL, facilitating the dematerialization and electronic settlement of securities, making the process more efficient and secure.
Several reforms and liberalization measures have been implemented over the years, including the introduction of online trading, the demutualization of stock exchanges, and the gradual opening up of the capital market to foreign investors.

These developments have contributed to the growth and maturity of the capital market in India, making it an important avenue for raising capital and facilitating investment in the country.

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Capital Market Instruments

Here are some different instruments of the capital market in India presented in a tabulated form:

Instrument	Description
Equity Shares	Represent ownership in a company; investors receive dividends and have voting rights.
Preference Shares	Carry preferential rights over equity shares, such as fixed dividend payouts and priority in case of liquidation.
Debentures	Long-term debt instruments issued by companies, providing fixed interest payments and repayment of principal.
Bonds	Fixed-income securities issued by governments and corporations, paying periodic interest and returning the principal at maturity.
Commercial Paper	Short-term unsecured promissory notes are issued by corporations to meet short-term funding needs.
Treasury Bills	Short-term government securities are issued to raise funds and manage the short-term liquidity needs of the government.
Mutual Funds	Pool funds from multiple investors to invest in a diversified portfolio of securities, managed by professional fund managers.
Exchange-Traded Funds (ETFs)	Invest in a basket of securities and trade on stock exchanges like individual stocks.
Real Estate Investment Trusts (REITs)	Enable investment in income-generating real estate assets, offering regular income and potential capital appreciation.
Infrastructure Investment Trusts (InvITs)	Allow investment in infrastructure projects, providing regular income through distributions from project cash flows.
Derivatives	Financial contracts with values derived from underlying assets, are used for hedging, speculation, and risk management.

These instruments provide individuals and institutions with various options to invest, raise capital, manage risks, and participate in the capital market in India.

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Capital Markets Functions

The capital markets serve several important functions that contribute to the efficient allocation of capital and facilitate economic growth. Here are the key functions of capital markets:

Capital Formation

Capital markets provide a platform for companies, governments, and other entities to raise long-term capital by issuing stocks, bonds, and other securities. This enables them to finance investments, expand operations, fund projects, and support economic development.

Investment Opportunities

Capital markets offer a wide range of investment opportunities to individuals and institutions. Investors can participate in the capital market by purchasing securities and earning returns through dividends, interest payments, and capital appreciation.

Liquidity Provision

Capital markets provide liquidity, allowing investors to buy and sell securities easily. The secondary market facilitates the transfer of securities, enabling investors to convert their investments into cash when needed.

Price Discovery

Capital markets help in determining the fair prices of securities through the interaction of buyers and sellers. The forces of supply and demand in the market determine the prices, reflecting the perceived value and market sentiment.

Risk Management

Capital markets provide instruments such as derivatives that enable investors to manage risks associated with price fluctuations, interest rate changes, and other market uncertainties. Hedging and risk transfer mechanisms offered by capital markets help in mitigating risk exposure.

Efficient Allocation of Capital

Capital markets play a crucial role in allocating capital to its most productive uses. Investors direct funds towards companies and projects with strong growth prospects, contributing to economic efficiency and resource allocation.

Wealth Creation and Distribution

Capital markets allow individuals and institutions to participate in wealth creation. Through investments in securities, investors have the opportunity to earn returns and accumulate wealth, which can contribute to wealth distribution and economic inclusiveness.

Corporate Governance and Transparency

Capital markets promote corporate governance practices by requiring listed companies to adhere to disclosure and reporting standards. This enhances transparency, accountability, and investor confidence in the financial system.

Overall, the functions of capital markets are essential in mobilizing savings, facilitating investment, managing risks, allocating capital efficiently, and supporting economic growth and development.

Read about: International Monetary Fund

Capital Market UPSC

The topic of Capital Market is important for the UPSC (Union Public Service Commission) exam as it is part of the UPSC syllabus for various exams like the Civil Services Examination (CSE). UPSC Online Coaching and UPSC Mock Tests often cover this topic to help aspirants prepare comprehensively.

Understanding the functioning of capital markets, their instruments, and their role in the economy is crucial for aspirants to analyze economic policies, evaluate financial implications, and comprehend the financial sector’s significance, which is relevant for UPSC exams assessing candidates’ knowledge of national and international issues.

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Capital Market FAQs