Capital Market - Study Notes

Lesson summary

The capital market refers to the facilities and institutional arrangements through which long-term funds, both debt and equity, are raised and invested. It channels the savings of the community into industry and commerce and consists of development banks, commercial banks and stock exchanges. An ideal capital market makes finance available at reasonable cost.

5.01 Meaning and definition

• A market where buyers and sellers trade financial securities such as bonds and stocks; participants are individuals and institutions.
• Defined as "a market for borrowing and lending of long-term capital funds required by business enterprises". It is an ideal source of external finance for medium-term and long-term funds.
• Like any market, it has borrowers (who demand funds) and lenders (who supply funds).
• Arun K. Datta: "a complex of institutions investment and practices with established links between the demand for and supply of different types of capital gains".

5.02 Characteristics

1. Securities market: dealings are in shares, debentures and the like.
2. Price: fixed by the demand and supply of securities.
3. Participants: individuals, corporate sectors, Government, banks and other financial institutions.
4. Location: not confined to specific places, though parts concentrate in stock exchanges.
5. Market for financial assets: a transaction platform for long-term financial assets.

5.03 Kinds of capital market

• Public issue: sale of securities to the public; the most common method for new companies.
• Rights issue: an existing company first offers additional securities to its existing shareholders on a pre-emptive basis.
• Private placement: sale of securities privately to a small group of investors.

5.04 Functions of capital market

1. Savings and capital formation: securities mobilise savings; reasonable return and liquidity encourage investment.
2. Permanent capital: companies get permanent funds while investors can sell their securities.
3. Industrial growth: resources move to industry through the stock exchange.
4. Ready and continuous market: easy marketability makes securities more liquid.
5. Reliable guide to performance of corporates, promoting efficiency.
6. Proper channelization of funds by market price and relative yield.
7. Variety of services: long and medium term loans, underwriting, promotion, equity participation, expert advice.
8. Development of backward and rural areas.
9. Foreign capital: bonds abroad and liberalised FDI bring foreign capital and technology.
10. Easy liquidity through the secondary market.

5.05 Evolution and growth in India

• 1947 to 1973: infrastructure built; IFCI, ICICI, IDBI, UTI, SFCs and SIDCs established.
• 1980 to 1992: debentures became a powerful instrument in the primary market; public sector bonds introduced; many stock exchanges set up; momentous growth in the secondary market.
• SEBI emerged as regulator of primary and secondary markets and protected small investors; credit rating introduced.
• Committees were set up to revamp the secondary market and the primary market.

5.06 New financial institutions

1. Venture fund institutions: equity financing for new and innovative project ideas and high-technology projects.
2. Mutual funds: channel small investors' savings into a diversified portfolio; run by LIC, UTI, SBI, Canara Bank; benefits are high return, liquidity, safety and tax benefits.
3. Factoring institutions: finance against account receivables and collect book debts; SBI Factors and Commercial Services (SBI) and Canbank Factors (Canara Bank).
4. OTCEI: trading across electronic counters nationwide; transparency, quick deals, faster settlement, better liquidity.
5. NSEI (1992): model exchange with nation-wide, screen-based, scripless and floorless trading.
6. NCDS: scripless settlement by book entry; three segments: National Trade Comparison and Reporting System, National Clearing System, National Depository System.
7. NSDL (1996): dematerialization and rematerialization of shares.
8. SHCIL: central securities depository and national clearing administration.

Other markets

• Foreign exchange market: largest, most liquid; above $5 trillion traded per day.
• Commodity market: about 50 major markets; hard commodities (gold, oil, rubber, iron ore) and soft commodities (wheat, cotton, coffee, sugar).
• Derivatives market: futures and options whose value comes from an underlying asset.
• Gilt-edged market: Government and semi-Government securities; guaranteed return, no speculation, dominated by LIC, GIC, PFs and banks.