Understanding Capital Market

Capital markets are financial markets dedicated to the buying and selling of long-term securities such as stocks and bonds. In simple terms, capital market means a system through which equity and debt instruments are issued and traded for long-term financing needs. This explanation addresses what is capital markets in the context of organised financial systems.

A capital market’s primary function is to channel funds from surplus units to entities requiring capital for productive use within the economy.

A capital market functions as a segment of the broader financial markets. In this, savings from households, institutions, and other investors are directed toward businesses, governments, and public sector bodies that need capital for long-term projects. This transfer typically occurs through the issuance and trading of securities such as equity shares, bonds, and debentures. The primary market enables issuers to raise fresh capital, while the secondary market provides liquidity by allowing existing securities to be bought and sold among market participants.

Intermediaries such as stock exchanges, brokers, depositories, and regulatory authorities play a structured role in ensuring that transactions are executed efficiently, transparently, and in compliance with regulations. Pricing in the capital market is influenced by demand and supply, corporate performance, economic conditions, and market sentiment, allowing securities to reflect prevailing valuations.

Over time, capital markets contribute to wealth creation by enabling long-term investment and by allocating financial resources to productive sectors of the economy. By linking savings with investment opportunities in an organised manner, capital markets support efficient resource allocation and sustained economic growth.

Capital markets can be broadly categorised based on the stage of securities issuance and the nature of instruments traded. Here is how they are categorised:

Primary Market

The primary market refers to the segment of the capital market where securities are offered to investors for the first time. Through this market, companies obtain long-term funds by issuing equity shares or debt instruments. The Initial Public Offering (IPO) is one of the mechanisms through which private companies go public and raise capital.

In this market, intermediaries such as merchant bankers, underwriters, and registrars are involved in issuance and compliance processes.

Secondary Market

Once securities are issued in the primary market, they are traded among investors in the secondary market. This market provides liquidity, enabling investors to buy or sell securities at market prices without affecting the company’s capital directly.

National Stock Exchange (NSE) and Bombay Stock Exchange (BSE) serve as major platforms for secondary market trading.

Debt Market

The debt market, also called the bond market, deals with fixed-income securities. Governments and corporates issue bonds and debentures to borrow funds. Investors receive periodic interest payments and principal repayment at maturity.

Equity Market

The equity market involves trading of shares that represent ownership in companies. Equity shareholders may receive dividends, and share prices may change over time based on market conditions. Shares can be common (ordinary) or preference shares with different rights.

Capital markets include a variety of platforms and instruments where long-term funds are raised and traded. Common examples include:

• Stock Markets – Where shares of publicly listed companies are bought and sold (e.g., BSE, NSE).

• Bond Markets – Where corporate or government bonds are issued and traded.

• Derivatives Markets – Where financial contracts like futures and options are traded. 

• Primary Markets – Where new securities are issued directly by companies (e.g., through IPOs).

• Secondary Markets – Where existing securities are traded among investors.

Capital markets feature a variety of financial instruments that differ in structure, return characteristics, and underlying obligations, such as:

• Equity Shares: Represent ownership; holders have voting rights and dividend claims.

• Preference Shares: Typically provide fixed dividends and have priority over common shares in asset claims.

• Bonds and Debentures: Debt instruments with fixed or floating interest rates; can be secured or unsecured.

• Mutual Funds: Pooled investment vehicles investing in equity and/or debt instruments.

• Derivatives: Contracts based on the value of underlying securities, including futures and options (overview only).

Capital markets comprise several interconnected participants and infrastructure components:

• Stock Exchanges: Platforms like NSE and BSE where securities are bought and sold.

• Regulatory Authorities: The Securities and Exchange Board of India (SEBI) oversees market integrity, investor protection, and regulation enforcement.

• Market Intermediaries: Brokers, merchant bankers, depositories (NSDL, CDSL), and registrars assist in trading, issuance, and settlement.

• Investors: Retail investors, institutional investors (mutual funds and insurance companies), and foreign portfolio investors (FPIs) participate in markets.

The functions of the capital market revolve around enabling the efficient movement of long-term funds within an economy. Capital markets support both capital formation and orderly trading through the following core functions:

• Mobilisation of savings:
  Capital markets channel savings from individuals and institutions into productive investments by providing avenues such as shares, bonds, and other long-term instruments.
  

• Price discovery:
  Through continuous buying and selling, capital markets help determine the market value of securities based on demand, supply, and available information.
  

• Liquidity provision:
  Investors are able to convert securities into cash through active secondary markets, ensuring ease of entry and exit without directly affecting the issuing entity.
  

• Risk distribution:
  By allowing participation from a wide range of investors, capital markets spread financial risk across multiple participants rather than concentrating it with a single entity.
  

• Corporate governance support:
  Regulatory disclosures, reporting requirements, and market oversight promote transparency and accountability among listed companies.
  

• Economic development facilitation:
  By supplying long-term capital to businesses, infrastructure projects, and governments, capital markets contribute to sustained economic growth.

Together, these functions explain how capital markets support financial stability, capital allocation, and economic activity in an organised manner.\

Capital markets operate as a component of the financial market, connecting entities that raise long-term capital with those that provide it. They illustrate how funds move through the economy and how long-term financing activities are organised.

Capital markets contribute to the economy through the following features:

• Provide long-term funding - support business activities and infrastructure projects.
  

• Facilitate capital allocation - channel funds toward different sectors of the economy.
  

• Support liquidity - enable securities to be traded in organised markets.
  

• Maintain transparency and regulation - function under regulatory frameworks that govern disclosures and market conduct.
  

• Expand market access - use electronic platforms to broaden participation within the financial market.

These features describe how capital markets function within the financial system and how they support capital flow and market operations.

Capital markets form a core part of modern economies by connecting entities that require long-term capital with those that provide it through financial instruments. Their structure, instruments, and functions explain how capital is raised, allocated, and traded within the financial system. Regulatory frameworks govern these markets to support transparency and orderly participation.

This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.