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Capital Market Instruments

A capital market allows investors to buy and sell securities like stocks and bonds. It brings together investors who buy securities with those who sell them. The three main participants are savers/investors, borrowers, and stockholders. There are two main types of capital markets - the primary market where new securities are issued, and the secondary market where existing securities are traded. Common capital market instruments include equity shares, preference shares, bonds, and debentures. Capital markets play an important role in allocating funds and stimulating economic growth.

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Janhavi Srivastava
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188 views4 pages

Capital Market Instruments

A capital market allows investors to buy and sell securities like stocks and bonds. It brings together investors who buy securities with those who sell them. The three main participants are savers/investors, borrowers, and stockholders. There are two main types of capital markets - the primary market where new securities are issued, and the secondary market where existing securities are traded. Common capital market instruments include equity shares, preference shares, bonds, and debentures. Capital markets play an important role in allocating funds and stimulating economic growth.

Uploaded by

Janhavi Srivastava
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Capital Market

A capital market is a financial market in which investors buy and sell


financial securities, such as stocks and bonds. These transactions take place
through various exchanges. A stock market, for example, is an exchange where
stock brokers and traders buy and sell stocks of public companies. A bond
market is an exchange where traders buy and sell bonds issued by corporations,
governments, or other entities.
The primary function of the capital market is to bring together investors
who buy securities with those who sell them. The three main participants of the
capital markets are savers (also known as investors), borrowers, and
stockholders.
The term capital market includes the stock market, bond market, and
related markets. The term is frequently used with reference to banks and
banking in both a narrow and broad sense. In the United States, the term is
sometimes used to include markets for saving and loans as well as bonds. The
units invested may be of any country.

Characteristics of Capital Market


As the capital market is the primary source where the finance is raised for
financing the activities of any business, the following characteristics must be
present in the capital market to make it effective.

Some of the important characteristics of a capital market are following:

 Security is the basic requirement for any kind of investment to make a


profit. Securities are the financial instruments that carry all the
information about the underlying assets, liabilities, income, and expenses.
 Brokers and dealers play an important role in the capital market. They act
as middlemen, that is, they buy and sell securities for their customers.
The brokers and dealers make their profit by collecting the brokerage
fees, which is a small percentage of the overall transaction value.
 Competition among the market players is a key factor in the capital
market.
 An active and competitive market is very important as it ensures that the
buyers and sellers get the best price for their investment. There must be a
proper system of transfer of ownership of securities so that they can
easily change hands.
Instruments of the Capital Market
The types of capital market instruments are broadly classified into two types -

1. Equity Security

a. 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.

b. 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.

2. Debt Security

It is a fixed income instrument, primarily issued by sovereign and


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

(a) Bonds

Bondholders are considered as creditors concerning such an entity


and are entitled to periodic interest payment. Furthermore, bonds
carry a fixed lock-in period. Therefore, issuers of bonds are
mandated to repay the principal amount on the maturity date to
bondholders.
(b) Debentures

Unlike bonds, debentures are unsecured investment options.


Consequently, they are not backed by any asset or collateral. Here,
lending is entirely based on mutual trust, and, herein, investors act
as potential creditors of an issuing institution or company.

All these four instruments are parts of the capital market.


Since each is unique and has distinguishing features, they are
useful in different ways for a company. Therefore, it is crucial to
understand the different types of capital market instruments so that
you can acknowledge their purposes.

Functions of the Capital Market


Irrespective of the capital market and its types, their functions are similar. These
are listed below -

 Enhance trading of securities

 Provides a common platform to both investors and savers

 Accumulation of capital for companies that need them

 Stimulates economic growth

 It improves the process of allocation of capital

 Prepares for continuity of funds availability

 It reduces information and transaction charges significantly.

 Faster valuation of securities.

 Provides proper channeling of funds to be used productively.

Therefore, the capital market is an effective medium for mobilizing funds


between investors and sellers. With the functions listed above, it is evident that
the capital market is not only a platform for fund transfer but also has its long-
term advantages.
It is useful in boosting national incomes, thereby enhancing the overall
economic growth of a nation as a whole. As a result, you will need to
understand the concepts from the grassroots to get an in-depth idea of a capital
market meaning and types, functions, and significance.

Types of Capital Market


The types of the capital market – primary and secondary are essential to
understand for Commerce students. Additionally, there are other divisions of the
capital market based on the traded security type - bond market and the stock
market.
Herein, we will focus on the former division of capital market types -
primary and secondary markets.

 Primary Market : Primary market is that part of the capital markets that
deals with the issuance of new securities. Companies, governments or
public sector institutions can obtain funding through the sale of a new
shares or bond issue. The primary market is the market where the
securities are sold for the first time. Therefore it is also called the New
Issue Market (NIM). The issue of securities by companies can take place
in any of the following methods:
 Initial public offer (IPO)
 Further issue of capital (FPO)
 Rights issue

 Secondary Market : The secondary market, also known as the


aftermarket, is the financial market where previously issued securities and
financial instruments such as stock, bonds, options, and futures are
bought and sold. The stock market or secondary market ensures free
marketability, negotiability and price discharge. : Between the types of
capital markets, 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. Secondary market has further two components:
Spot Market: Where securities are traded for immediate delivery and payment.
Futures Market: Where the securities are traded for future delivery and
payment.

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