The functions of capital market are defined as funneling fund inflows from savers to borrowers. It is thus a financial marketplace that buys and sells long-term investment products, including equity and debt instruments. Therefore, it will create liquidity, mobilize savings, generate opportunities for capital formation, and bring stability in the economy. The capital market will do this by bridging the gap between investors and businesses, which will provide resources for expansion and development. This article discusses the capital market’s functions, types, and essential elements.
What is Capital Market?
The capital market is a marketplace where financial products are traded. Some examples of capital markets include the stock market, bond, and currency markets, or forex. It lowers the difficulty in terms of buying and selling financial instruments such as zero-coupon bonds, preference shares, debentures, and equity shares.
Capital markets support organizations by providing a means through which one can obtain capital to run companies or increase wealth. Capital markets usually offer financial instruments like ownership shares in a firm- stocks or other debt assets like bonds, which also carry interest.
Functions of Capital Market
The functions of capital market are Important for the smooth functioning of the economy. It plays a key role in driving economic development by linking the savers with various entities that need capital. Some of the key functions of the capital market include:
Mobilization of Savings
Mobilizing Savings for investment is a key function of capital markets. Capital markets act as a conduit that channels personal or institutional savings into productive investments. For example, individuals and institutional investors buy securities in the form of stocks, bonds, or mutual funds, thereby converting their savings into investment capital.
The capital is then used by firms, governments, and other institutions for funding projects, operations, or expansions. The process thereby finances economic activities and enables the savers to enjoy returns from their investments in the general course of the expansion and development of the economy.
Capital Formation
One of the most important roles played by capital markets is in facilitating the formation of capital. The third function is that of Wealth Generation, in which individuals and institutions grow their wealth by investing in financial instruments such as stocks, bonds, and mutual funds, thus providing capital with a possible possibility of being capitalized and having an income yield.
Such investments may lead to significant returns over time and help in the accumulation of wealth for investors. This function is helpful for all investors and also boosts economic growth by reinvesting and circulating within the economy.
Liquidity Provision
The providing of liquidity is one of the capital market functions that enables the easy buying or selling of securities with the investors. Therefore, Liquidity means the assets are readily convertible into cash quickly, without affecting it much.
It is imperative for the successful operation of the market. Additionally, it made sure investors had their cash when needed hence boosting confidence within the market. High liquidity of capital markets in both individual investment and the macro-economy plays a vital role.
Facilitates Price Discovery
The price determination in capital markets is one of the key functions. The market decides the prices of the securities that including stocks and bonds. It is mainly based on the supply and demand present in the market. This may be influenced by company performance, economic conditions at the time, and investor sentiment.
Prices are variable since their value reflects that of the marketplace in real-time. Mechanisms such as this one allow for greater clarity in trading and assure investors make smart decisions based on what they perceive the value or potential within an asset to be.
Economic Stability
One of the basic capital market functions is facilitating economic growth. As the savings and investments find channels into their productive purposes new business ventures or infrastructure projects for funding or an expansion of current companies money inflow causes business activities as it increases job opportunities and contributes to the adoption of technology.
Capital markets are one of the significant factors in promoting the overall development and growth of a country as they effectively channel resources to where they would yield the greatest returns, thereby contributing to a healthier, stronger economy.
Encourages Foreign Investment
Foreign investment opportunities include all capital market functions, which refer to access to a wide variety of international investment options. Investors can diversify their portfolios beyond local markets by investing in foreign stocks, bonds, and mutual funds.
It has the advantage of reaching global investment opportunities to tap the growth potential of different economies and industries around the world. This helps spread the risk because the fluctuations in a country’s market can be offset by stability or gains in another, which may enhance the prospect of portfolio growth and stability.
Risk Diversification
Diversification of risk in capital markets refers to the spread of investment across different financial instruments, sectors, or markets to minimize the risk of loss. A portfolio can be diversified by an investor investing in a mix of assets like stocks, bonds, and mutual funds, which will minimize the potential losses in any one area.
It is founded on the idea that not all markets or sectors go in the same direction at the same time. Diversifying investments allows balancing the portfolio to ensure that stability or gains in others will offset the downturn in one investment.
Functions of Indian Capital Market
The Indian capital market, governed by the Securities and Exchange Board of India (SEBI), functions similarly but aims to promote home-grown economic growth. It provides industrial finance and investment avenues and transparency in financial transactions.
Types of Capital Market
The capital market is categorized into two types, namely primary and secondary markets. Both of these markets offer different kinds of services. The primary market offers new issues of securities whereby firms can raise fresh capital. On the other hand, the secondary market allows trading in existing securities, thereby making them liquid and providing price discovery.
Primary Market
The primary market is the market where new securities are first issued. The raising of fresh capital for companies is facilitated through initial public offerings, private placements, and rights issues.
A primary market function is to raise funds directly for investor companies. Provides avenues for capital formation through issues of equity and debt instruments. Entrepreneurial ventures are promoted by financing start-ups and new projects.
Secondary Market
The secondary market is the trade of existing securities among investors. It gives a platform and allows for the buying and selling of stocks, bonds, and other financial instruments and ensures liquidity.
Secondary Market Functions Ensure liquidity by enabling investors to trade their holdings. It reflects the performance of companies through fluctuations in stock prices. It aids in price discovery for securities.
Elements of Capital Market
Market sources of funds include individual investors, financial institutions, insurance companies, commercial banks, businesses, and retirement funds.
- Securities: These include stocks, bonds, debentures, and other financial instruments.
- Investors: Individuals, institutions, mutual funds, pension funds, and insurance companies that buy and sell securities.
- Intermediaries: Intermediaries are firms like brokers, investment banks, and financial advisors who facilitate the transactions.
- Regulatory Bodies: Organizations that regulate market activities to ensure compliance with laws and protect investors.
- Exchanges: Platforms like the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE) where securities are traded.
Functions of Capital Market FAQs
What are the functions of capital market?
Functions of capital market are mobilizing savings, providing avenues for capital formation, ensuring liquidity, enabling price discovery, and promoting stability in the economy.
What are the differences between primary and secondary capital markets?
Primary market refers to the issues of new securities while the secondary market provides an avenue to trade existing securities among investors.
What are the functions of Indian capital market?
The Indian capital market serves the broader role of generating funds for industrial growth, an avenue to attract foreign investments and ensuring that there are transparent financial transactions.
What are the capital market instruments?
Examples: stock, bonds, mutual funds, debentures, and derivatives.
Why is liquidity important in the capital market?
Liquidity makes it easier for investors to acquire or sell securities, thus making the market more attractive and efficient.
