What is Capital Market?

Meaning, Functions and Role
Meaning and Concept of Capital Market

Capital Market is one of the significant aspect of every financial market. Hence it is necessary to study its correct meaning. Broadly speaking the capital market is a market for financial assets which have a long or indefinite maturity. Unlike money market instruments the capital market intruments become mature for the period above one year. It is an institutional arrangement to borrow and lend money for a longer period of time. It consists of financial institutions like IDBI, ICICI, UTI, LIC, etc. These institutions play the role of lenders in the capital market. Business units and corporate are the borrowers in the capital market. Capital

Capital market provides long term debt and equity finance for the government and the corporate sector. Capital market can be classified into primary and secondary markets. The primary market is a market for new shares, where as in the secondary market the existing securities are traded. Capital market institutions provide rupee loans, foreign exchange loans, consultancy services and underwriting.
market involves various instruments which can be used for financial transactions.

While the money market deals with the provision of short-term credit, the capital market deals in the lending and borrowing of medium-term and long-term and long-term credit.

Significance, Role or Functions of Capital Market

Like the money market capital market is also very important. It plays a significant role in the national economy. A developed, dynamic and vibrant capital market can immensely contribute for speedy economic growth and development.

Functions.

the mobilized savings are made available to various segments such as agriculture. etc. insurance policies.Continuous Availability of Funds : Capital market is place where the investment avenue is continuously available for long term investment. etc. It includes long term and medium term loans to industry. Thus it stimulates industrial growth and economic development of the country by mobilising funds for investment in the corporate securities. Mobilization of savings and acceleration of capital formation. Instruments such as bonds. Thus it provides an investment avenue for people who wish to invest resources for a long period of time.. increasing production and productivity in economy by generation of employment and development of infrastructure. underwriting services. It provides suitable interest rate returns also to investors. etc. 5. This helps in increasing capital formation. Capital formation is net addition to the existing stock of capital in the economy. Basically capital market transactions are related to the stock exchanges. It can have regulation over the resources so that it can direct funds in a qualitative manner. As it makes funds available for long period of time. This is a liquid market as it makes fund available on continues basis. In developing countries like India plagued by paucity of resources and increasing demand for investments by industrial organizations and governments. 7. Promotion of industrial growth. 8. definitely provides diverse investment avenue for the public. .1Capital Formation : Capital market helps in capital formation. industry. 4. These services help the manufacturing sector in a large spectrum. The capital market is a central market through which resources are transferred to the industrial sector of the economy. Through mobilization of ideal resources it generates savings. 2. The existence of such an institution encourages people to invest in productive channels rather than in the unproductive sectors like real estate. the financial requirements of business houses are met by the capital market. export finance. equities. bullion etc.Provision of Investment Avenue : Capital market raises resources for longer periods of time.Proper Regulation of Funds : Capital markets not only helps in fund mobilization.Speed up Economic Growth and Development : Capital market enhances production and productivity in the national economy. Both buyers and seller can easily buy and sell securities as they are continuously available. 3. 6. This helps in. but it also helps in proper allocation of these resources.Service Provision : As an important financial set up capital market provides various types of services. the importance of the capital market is self evident. consultancy services. It helps in research and development. units of mutual funds.

10. IFCI. IDBI. The stock exchange resolves this clash of interests by offering an opportunity to investors to buy or sell their securities while permanent capital with the company remains unaffected. and (v) expert advice on management of investment in industrial securities. Proper channelisation of funds. The existence of a stock exchange enables companies to raise permanent capital. Structure of the capital market-. Provision of a variety of services. Raising long-term capital. SFCs. provide long-term and . The financial institutions functioning in the capital market provide a variety of services. . (1) The financial institution. The stock exchange provides a central convenient place where buyers and sellers can easily purchase and sell securities. The financial institutions. The investors cannot commit their funds for a permanent period but companies require funds permanently. the more important ones being the following: (I) grant of long-term and medium-term loans to entrepreneurs to enable them to establish. e. LIC. UTI etc. Broadly describe.g. Ready and continuous market. (II) provision of underwriting facilities. the capital market can be divided into two constituents. 13.two constituents. This ensures effective utilization of funds in the public interest. (IV) participation in equity capital. and (2) the securities market. expand or modernize business units. An efficient capital market not only creates liquidity through its pricing mechanism but also functions to allocate resources to the most efficient industries. 11. (III) assistance in the promotion of companies (this function is done by the development banks like the IDBI). The element of easy marketability makes investment in securities more liquid as compared to other assets. 12.. The prevailing market price of a security and relative yield are the guiding factors for the people to channelise their funds in a particular company.

The secondary market deals in old issues of government loans and operates largely through a few large stockbrokers who keep in touch with the Reserve Bank and other prospective buyers and sellers.B. 3.medium-term loan facilities. etc. Since the government cannot default on its payment obligations. payment on time. The government securities market consists of two parts .the new issues market and the secondary market. "there are only brokers or investors in the market and no dealers or jobbers (other than the RBI) who would make a market in government loans by standing ready to buy and sell any amount of government securities on their own account. Reserve Bank of India plays a dominant role in the government securities market. GILT-EDGED MARKET The gilt edged market is the market in government securities or the securities guaranteed (as to both principle and interest) by the government. Since it is the Reserve Bank of India that manages entirely the public debt operations of the Central as well as the State governments. As noted by S. It is a risk free market and returns are guaranteed. it is responsible for all the new issues of government loans. there is no uncertainty regarding yield. Accordingly. 1. CORPORATE SECURITIES MARKET . and there is no scope for speculation and manipulation ') of the market. 5. Government securities are the most liquid debt instruments. The transactions in the government securities market are very large and each transaction may run into several crores of rupees. The securities market is divided into (i) the gilt edged market and (ii) the corporate securities market. the government securities are risk free and hence are known as gilt-edged (which means ‘of the best quality’). Gupta."2 4. 2.

1. 1956 defines a stock exchange as "an association. its financial position. 3. This results in substantial saving as the cost of raising capital in this method is less than the cost of raising capital via other methods.e. By offer for sale. shares. It consists of the new issues market (the primary market) and the stock exchange (the secondary market). debentures. a statement like prospectus is issued for sale of shares to the public. The new issues market is also known the primary market. organization or body of individuals. The stock exchange (or the secondary market) is a highly organised market for the purchase and sale of second-hand quoted or listed securities 'Quoting' or 'listing' of a particular security implies incorporating that security in the register of the stock exchange so that it can be bought and sold there. 2. The prospectus is an invitation to the general public for subscribing to the capital. Later. 4.Corporate securities market is a market where securities issued by corporate firms (Le. This method is almost similar to the prospectus method except with a difference that initially shares are taken up by a third party in bulk. bonds. shares. Under this arrangement. bonds and debentures) can be bought and sold freely. and so on. By prospectus. the shareholders have the right to a certain number of shares in proportion to the shares held by them. Companies may also raise capital from the existing shareholders by making a rights issue. The New Issues Market. By private placing. Capital can be raised from the general public by the issue of prospectus. The prospectus must contain various details regarding particulars of the company. . etc. Under a rights issue. whether incorporated or not. The Securities Contracts (Regulation) Act. By offering rights issue. the shares are sold to individuals or institutions directly by making a private appeal to them. The Stock Exchange. The new issues market is that part of the capital market which is concerned with the issue of new securities. i.

The gross market borrowings of the Central and State governments rose to Rs. 12.000 crore in 1991-92 rose to as high as Rs. The secondary market turnover of government securities registered spectacular increase since mid-1990s.established for the purpose of assisting. The maturity structure of debt has significantly shifted in favour of medium-term and short-term borrowings. wide and vibrant gilt-edged market has emerged as a result of a series of structural and institutional reforms. the investor base for government securities has expanded rapidly. a deep. Capital issues consist of two parts . 99. debentures were a more popular means of raising long-term funds and provided almost 70 per cent or more resources raised through new capital issues. (1) Primary Market or the New Issues Market New Capital Issues by Private Sector." GROWTH OF CAPITAL MARKET IN INDIA Government securities market Since 1991.630 crore in 1999-2000.based primary issuance of government securities which was about Rs. corporates and financial institutions have also begun to invest in government securities. . the corporate securities market got a tremendous boost in the first three-four years of the post-liberalisation phase. finance companies.81. Besides banks and insurance corporations.shares and debentures.2 This is due to a substantial rally in the government securities market. 1992. The amount of market . selling and dealing in securities.747 crore during 2005-06.3 Corporate Securities Market Consequent upon the policy of liberalisation adopted by the government in July 1991 and the subsequent abolition of Capital Issues Control with effect form May 29. regulating and controlling business in buying. As far as secondary market is concerned. 1. Prior to 1992-93.

29.350 2006 1. In 2004-05 there was a steep fall in resources mobilisation through mutual funds. They enhance the efficiency of the flow of savings. It was as low as Rs.000 2004 1. Debt Market is however dominated by government bonds.383 66 389 Source: Economic Survey 2005-06.213 2003 1.000 4.47. 70 and 76. as many as 81. The mutual funds (MFs) have proved to be important conduits of mobilising resources particularly since 1987-88 when the public sector banks were allowed to set up subsidiaries to undertake mutual fund business. i. These markets are an important element in mobilisation of resources. Table Issuance of Bonds 2002 Government of India bonds Corporate Bonds 1. Debt Market.780 crare by mutual funds (of this. MF subsidiaries of public sector banks.20.4 Secondary Market Secondary market refers to stock exchanges where existing securities can be regularly purchased and sold.13. At present this country has four types of mutual funds .e. namely equity shares and preference shares. The Indian debt market is composed of government bonds and corporate bonds. they enjoy certain rights like voting power.68 and 74 and Economic Survey 2006-07.Unit Trust of India.. pp. receipt of profits in the form of dividends etc. The year 2005-06 recorded the highest ever resource mobilisation of Rs. The . A company can issue two types of shares. 2. the Government of India are the predominant and most liquid component of the bond market. So. 52. and private sector MFs.4 per cent resources were mobilised by the private sector mutual funds).600 2005 1. Government bonds are usually much less volatile than equities and far more liquid than equities.201 crore.284 2. pp. Bonds issued by the Central government.549 5.19.The persons who hold shares are known as shareholders or members and are part owners of the company. Mutual Funds. MF subsidiaries of investment institutions like LlC and GIC.

7 3. holders of securities can easily dispose of their securities and obtain cash. BSE slipped by one position to sixth while NSE retained its third position.98.25. Table 47.4 9. The biggest stock exchange of India is the National Stock Exchange (NSE) which was set up in November 1992. 2005 and 2006.755 49. It started its trading operations effective June 30.existence of these markets fulfils a basic need of the investors namely the liquidity. Only the debt market segment of the NSE was put into operation initially The second largest stock exchange in India is the Bombay Stock Exchange (BSE).745 34. NSE AND SSE. statistical outline of India. It was the first organised stock exchange established in India at Mumbai as far back as 1887. Presently NSE and BSE account for almost the entire trading of scrips on Indian stock markets and most of the regional stock exchanges have been rendered redundant.60. 2004 and 2005 NSE and BSE ranked third and fifth respectively in the world on the basis of the number of transactions. 1994.select stock market indicators in India Year 197576 8 198586 14 1997-98 2000-01 2004-05 2005-06 Stock exchange (No. 2004. Table2. In 2003.7 7.5 Source: Tata services Ltd. 1996-97.235 6.3 shows 10 biggest stock exchanges by number of transactions in 2003. International Comparison.302 5.680 78.) Market value of capital(Rs.. .028 60. In 2006.6 10.crore) Capital raised as % of gross domestic saving(%) 22 23 23 23 3. Thus viable secondary markets by providing marketability to securities encourage savers to take risk and make investments in the existing securities.189 98 1.0 6.428 30.553 16.273 25.22.322 0. In these markets.crore) Capital issues (Rs.

2. Increasing awareness of investment opportunities. Life Insurance Corporations of India etc. Credit rating agenices. 4. various State Financial Corporations (SFCs) at the State level. Business newspapers and financial journals.e. Industrial Development Bank of India (lOBI) in 1964. 3. Business Standard. 5. Business Today. Business India. 14 major commercial banks were nationalised in 1969. The early post-Liberalisations phase witnessed increasing interest in the stock markets. the Board has been mandated to create an environment which would facilitate mobilisation of adequate resources through the securities market and its efficient allocation. As a result. Industrial Reconstruction Corporation of India (IRCI) in 1971. The last few years have witnessed increasing awareness of investment opportunities among the general public. the government set up the Industrial Finance Corporation of India (IFCI) in 1948. The Securities and Exchange Board of India (SEBI) was set up in 1988 and was given statutory recognition in 1992.. With a view to providing long-term funds to industry. There are three credit rating agencies operating in India at present CRISIL. State Industrial Development Corporations. In addition.) have made the people increasingly aware of new long-term investment opportunities in the securities market. Setting up of SEBI. i. CRISIL (the Credit Rating Information Services of . Unit Trust of India (UTI) in 1964. ICRA and CARE. public issues of most of the good companies were oversubscribed many times. soon after Independence. Among other things. Establishment of development banks and industrial financing institutions.FACTORS CONTRIBUTING TO THE GROWTH OF CAPITAL MARKET IN INDIA 1. The small investor who earlier shied away from the securities market and trusted the traditional modes of investment (deposits in commercial banks and post offices) showed marked preference in favour of shares and debentures. Money Outlook etc. Growing public confidence. (The Economic Times. The Financial Express. This was followed by the setting up of a number of other development banks and financial institutions like the Industrial Credit and Investment Corporation of India (ICICI) in 1955. Business Line. Business World.

Each subbroker in the chain introduced a mark-up in the price and the investor thus had to pay a much higher price than the actual trade price. Retail investors. As of 1992. and imposed entry barriers. 4. 5. the chief among them being as follows: 5 1. 3. 2. (the Investment Information and Credit Rating Agency of India Limited) was set up in 1991 and CARE (Credit Analysis and Research Limited) was set up in 1993. the pre 1991 period) the Indian equity market was confronted with a number of problems. ICRA Ltd. accessed market liquidity through a chain of intermediaries called 'sub-brokers'. in the pre-reform phase (i. so that external users of a market often found themselves at the losing end of price movements. PROBLEMS OF INDIAN CAPITA.e. As with all trading-floors. A variety of manipulative practices prevailed. It was usual for brokers to charge the investor a much higher price from that actually traded at. PROBLEMS OF THE DEBT MARKET .India Limited) was set up in 1988. Trading took place by 'open outcry' on the trading floor. the Bombay Stock Exchange (BSE) was a monopoly. which was inaccessible to users. which led to increased costs of intermediation. No strict action could be taken against errant brokers. It was an association of brokers. there was no price-time priority.L MARKET: THE PREREFORM PHASE PROBLEMS OF THE EQUITY MARKET According to Ajay Shah. and particularly users of the market outside Mumbai. so users of the market were not assured that a trade was executed at the best possible price.

dealer markets suffered from a fragmentation of orders and trades. the period after 1991). the Indian debt market faced the following important problems in the pre-reform phase. 2. and there was no price-time priority to ensure that each trade took place at the best price in the country.e. trade prices were not centrally reported and observed. a set of participants with homogeneous credit risk. The lack of anonymity made it easier to form and enforce cartels which would indulge in a lot of manipulative practices. as with the Bombay stock exchange. Since traders took place bilaterally. There were serious problems with the settlement of trades.SGL was maintained manually.According to ajay shah. the debt market was effectively restricted to Mumbai. did not unbundled their intermediation price from the transaction price.Personal and political influences impacted upon trade prices. 3. 4. A brief discussion of important measures follows. STRENGTHENING THE CAPITAL MARKET: THE POSTREFORM PHASE In the post-reform phase (i. . even ex post. The reserve bank tracks ownership of government securities of trades. the Government of India has initiated a number of steps to strengthen the capital market. 7. Trades were bilaterally struck between known counterparties without anonymity. In 1992. 5. The problem of credit risk served to narrow the Market down to a ‘club market’. The debt market relied on dealers who. 6. each leg of the transaction was exposed to the credit risk of the other. Trading took place by telephone in Mumbai. The reserve bank tracks ownership of government securities in a database called the SGL. debt trading took place without an exchange in the picture. Hence. 1.

. conversion of auction Treasury Bills into term securities. STCI was set up with total capital of Rs. 4. Some innovative instruments. 3. 500 crore and it commenced operations from June 1994. 6. Zero Coupon and Capital Indexed Bonds. the SEBI has been mandated to create an environment which would facilitate mobilisation of adequate resources through the securities market and its efficient allocation. A system of Primary Dealers was established in March 1995 and the guidelines for Satellite Dealers were issued in December 1996. Tap Stocks and partly paid stocks were introduced. foreign central banks and other specified bodies with whom the Reserve Bank had an arrangement to invest their temporary surplus funds. (2) registering and regulating the working of stock brokers and other intermediaries associated with the securities markets.Steps to Strengthen the Government Securities Market 1. Among other things. A scheme of 14-day Intermediate Treasury Bills was introduced effective from April 1997 to enable State governments. (4) promoting and regulating the self- . 5. Retail trading in government securities at select stock exchanges commenced in January 20036 Securities and Exchange Board· of India The Securities and Exchange Board of India (SEBI) set up in 1988 was given statutory recognition in 1992 on recommendations of the Narasimham Committee. such as. 1992. The auction system for the sale of Government of India medium and long-term securities was introduced from June 3. 2. A practice of pre-announcing a calender of treasury bills and government securities auctions to the market was introduced. The purposes and aims of SEBI are as follows: (1) regulating the business in stock markets and other securities markets. (3) registering and regulating the working of collective investment schemes including mutual funds. The Government of India set up the Securities Trading Corporation of India (STCI) to develop institutional structure for a vibrant secondary market in government securities.

NSE was set up in November 1992 and was owned by IDBI. National Securities Clearing Corporation As stated earlier. As stated earlier. NSE is a securities exchange which marks a radical break with the past. (7) prohibiting insider trading in securities National Stock Exchange of India As stated earlier.as a result of NSE. It commenced its operations in 1994. Therefore NSE's staff is free of pressures from brokers and is able to perform its regulatory and enforcement functions more effectively. computerised order-matching with strict price-time priority. Effective on July 4. The BSE responded rapidly by moving to similar technology in March 1995. 1996. were avoided by using satellite communications.000 new brokerage firms have entered the market. To tackle this problem. (iii) competition in the brokerage industry .000 satellite terminals all over the country (3) NSE is not 'owned' by brokers. the regime in which trading on NSE operates is characterised by four key innovations:7 (1) The physical floor was replaced by anonymous. (6) promoting investors' education and training of intermediaries of securities market. equity trading at NSE commenced in November 1994. Small counterparty risks could turn into large counterparty risks owing to cascading effects. the National Securities Clearing Corporation (NSCC) was set up in 1996. According to Ajay Shah. (5) prohibbiting fraudulent and unfair trade practices relating to securities markets. trading in the securities market in the pre-reform phase was fraught with counterparty risks. Now NSE has a network of 2.electronic trading is completely transparent about prices and quantities. and brokers are franchisees. (2) The limitations of being in Mumbai.regulatory organisations. (ii) anonymity . (4) Traditional practices of unreliable fortnightly settlement cycle with the escape clause of badla were replaced by a strict weekly settlement cycle without badla. and completely opaque about identities. about 1. jeopardising the functioning of the entire market.users could look at a price on a computer screen before placing on order. the NSCC started . and the limitations of India's public telecom network. It is a limited liability company. the improvements that accompanied this regime were are follows: (i) transparency . According to Ajay Shah. UTI and other public sector institutions.

National Securities Depository Limited (NSDL) was set up in November 1996. 1992. Theft or counterfeiting of share certificates gave rise to a number of criminal activities.501. 2006. This automatically ends the risk of cascading failures generating a payments crisis. This form of trading is being extended in phases and more and more shares of more and more companies are being brought under it. introduce certain procedural norms for the issuers and intermediaries. companies available for demat numbered 11. 2.563 crore and the value of demat amounted to Rs. 3. The basic objective of such inspections is to improve the functioning of stock exchanges. Under this programme. do continue to be) printed on paper.84."8 DEMATERIALISATION . Total shares settled in demat were 6. To tackle this problem. As on March 31. The objective is to strengthen the standards of disclosure. .9 SEBI AND CAPITAL MARKET DEVELOPMENT To introduce improved practices and greater transparency in the capital markets in the interest of healthy capital market development. The final leg of a transaction is where the title on a security is changed from the seller to the buyer.guaranteeing all trades on NSE. inspections of some stock exchanges has already been carried out. Thus every trade that takes place is freed from the risk of the counter party defaulting. and remove the inadequacies and systemic deficiencies in the issue procedures. The important steps are: 1. SEBI has introduced a number of measures to reform the primary market. Since share certificates in India were (and. 7. a number of steps have -been taken by SEBI. The process of registration of intermediaries such as stock brokers and subbrokers has been provided under the provisions of the Securities and Exchange Board of India Act. for most companies.860 crore in 2005-06. trading in them was fraught with operational cost and risk. SEBI has drawn up a programme for inspecting stock exchanges.

7. In fact. in particular.. the Indian capital market was regarded as one of the worst as it figured almost at the bottom of the league. The 'Banker to the issue' has been brought under purview of SEBI for investor protection. CONCLUSION The Indian capital market has witnessed a radical transformation within a period of just over one decade. the setting up and extension of activities of NSE. it is now considered to be way ahead of many developed country capital markets. SEBI issued a separate set of guidelines for development financial institutions in Septembers 1992 for disclosure and investment protection regarding their raising of funds from the market. safety.10 . As per the guidelines. For the first time mutual funds are governed by a uniform set of regulations which require them to be formed as trusts and managed by a separate asset management company (AMC) and supervised by a board of trustees or trustee company. However.Unit Trust of India (UTI) has also been brought under the regulatory jurisdiction of SEBI. SEBI issued regulations pertaining to "Insider Trading" in November 1992 prohibiting dealings. and in the long run inspire investor confidence in the market. SEBI has directed the stock exchanges to broad-base their governing boards and change the composition of their arbitration. communication or counselling in matters relating to insider trading. Such regulations will help in protecting and preserving the market's integrity. 8. Besides.4. underwriting is not mandatory. SEBI has notified the regulations for mutual funds. was low. there is no need for promoter's contribution. the Indian capital market is now ranked in the top league. the scenario has now completely changed. and steps taken by SEBI. With reference to the risk indices. Through an order under the Securities Contracts (Regulations) Act. market integrity etc. default and disciplinary committees. Because of extensive capital market reforms carried out over the period of the last one decade or so. 6. During the early part of 1990s the ranking of Indian capital market with reference to global standards of efficiency. 1956. 5.

fully convertible cumulative redeemable preference shares etc. as correctly pointed out by R.". And. "The operations of the Fils in India are often sporadic as their buy and sell decisions are governed by global strategies in which the Indian market continues to be a marginal player. However. the sentiments look positive due to revival of retail investor interest in the market following encouraging corporate performance in recent period. A wide variety of innovative/ hybrid instruments were introduced to suit varied needs of investors and issuers/borrowers.11 Therefore. external shocks can destabilise the Indian capital market at any time and it is necessary to take adequate precautionary steps to avoid/prevent this possibility.H. Some of the instruments which became quite popular were secured premium notes (SPN) with detachable warrants. zero-interest equity shares with detachable equity warrants. nonconvertible debentures with detachable equity warrants. Despite setback in some years due to stock market scams.A significant feature of the primary market activity after abolition of capital controls has been that the corporates attempted to diversify the range of instruments.Patil. . what continues to be a matter of concern is the fact that it is the foreign institutional investors (Fils) that call the shots in the Indian capital market due to the vast amount of resources at their command.

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