Capital Market — Meaning, Features and Structure

Meaning of the capital market. The capital market is the market for long-term funds — financial claims and instruments with a maturity period exceeding one year, or with no fixed maturity at all (as with equity shares). It is where businesses and the government raise long-term finance — for setting up new projects, expanding capacity, or funding long-term public expenditure — from household and institutional savers who wish to invest their surplus funds for a longer horizon in exchange for a return.

Features of the capital market, which mark it out clearly from the money market covered earlier in this chapter:

• Deals in long-term securities (equity shares, debentures/bonds), not short-term claims.
• Connects long-term savers directly with industry and government, financing fixed capital formation rather than working-capital needs.
• Carries higher risk than the money market, since long-term returns depend on how a business or project performs over an extended period, and the principal itself is generally not guaranteed the way a Treasury Bill's is. Prices of capital market securities can fluctuate considerably, and while listed securities can usually be sold on a stock exchange, this is not as instant or assured as redeeming a money market instrument on its fixed, near-term maturity date.
• Regulated primarily by the Securities and Exchange Board of India (SEBI), rather than the RBI (whose primary domain is the money market and the banking system).

Structure of the capital market:

• Primary market (new issue market) — where companies and the government raise fresh capital by issuing new securities directly to investors for the first time: an Initial Public Offer (IPO), a Follow-on Public Offer (FPO) by an already-listed company, a rights issue to existing shareholders, or a private placement to select investors. Funds raised here flow directly to the issuing company or government.
• Secondary market — where securities that have already been issued are bought and sold among investors, through recognised stock exchanges. The secondary market does not raise fresh capital for the issuer, but it gives existing investors an exit route and continuous price discovery, which is exactly what makes investors willing to subscribe to new issues in the primary market in the first place — nobody would buy a long-term security readily if there were no way to sell it again before its natural end.
• Gilt-edged market — the market for government securities (Central and State government bonds, often called G-Secs), so named because government paper was historically considered as safe and reliable as gold-edged (gilt-edged) certificates. Backed by a sovereign guarantee, gilt-edged securities are the safest capital-market instrument, and the RBI manages their issuance and conducts open market operations in this very market as one of its monetary-policy tools.
• Industrial securities market — the market for shares and debentures issued by industrial and commercial companies, itself divided into its own primary segment (new share/debenture issues) and secondary segment (exchange trading of already-issued shares/debentures). …