Most Indian capital markets are regulated and supervised by their securities, and their respective acts and statutes are enacted through the relevant entities that exist to facilitate and holistically govern the markets in India. Thus, this website explains the nature and types of capital markets in India and sets out the conditions under which it would be operated. The capital market is a vital financial system encouraging long-term investments and wealth accumulation. It fulfills the necessity for capital by linking investors with surplus funds and businesses or governments requiring funds for expansion or development.
Structure of Capital Market
The capital market is a vital financial system encouraging long-term investments and wealth accumulation. It fulfills the necessity for capital by linking investors with surplus funds and businesses or governments requiring funds for expansion or development. Capital markets deal with long-term financial securities, including bonds, stocks, and debentures, unlike the money market, which connects short-term instruments (like treasury bills and commercial papers) for less than a year. The capital market may be classified, in a broad sense, in the following manner:
- Primary Market-An institution where fresh securities are issued.
- Secondary Market-Where existing securities are bought and sold.
The capital market consists of various intermediaries and institutions, as well as financial instruments that help in the regulation and facilitation of investment activities. In the following, we will take a closer look at the structure of the capital market.
Primary Market (New Issue Market – NIM)
The primary market is where new securities are issued for the first time by companies, governments, or financial institutions. It also enables organizations to raise fresh capital directly from investors by selling these securities. After the issue, these securities can be traded in the secondary market.
Characteristics of the Primary Market
1. Only initially sold to investors.
2. Assure Assure companies of raising capital for the company’s expansion – mergers and acquisitions-debt repayment.
3. Transactions take place once only – at the time of issue.
4. No secondary trading; late, the securities are listed on stock exchanges.
Main Instruments in the Primary Market
- Initial Public Offering (IPO): A company issues shares to the public for the first time to mobilize capital. Example: Facebook IPOed in 2012 for $16 billion.
- Follow-on Public Offering (FPO): An issuance of additional shares by an already listed company to raise capital.
- Rights Issue: Existing shareholders are given the right to purchase additional shares at a discount.
- Private Placements: Securities are sold to small investors, excluding the general public (e.g., institutional investors).
- Preferential Allotment: Shares are issued to a specified group of investors, usually at a predetermined price.
Secondary Market
The secondary market is a platform for investors to buy and sell securities previously authorized for sale. Unlike the initial markets where funds went to the issuing company, this market is characterised by investor transactions. It thus confers liquidity and price discovery to the extent of making the securities tradable.
Key Features of the Secondary Market
- Give access to buying and selling for investors of existing securities.
- Provides liquidity, assisting investors in exiting their investments.
- Prices fluctuate by forces of supply and demand.
- Transactions occur on stock exchanges or through over-the-counter (OTC) markets.
Main Segments of the Secondary Market
1. Stock Exchanges (Organized Market): Stock exchanges are centralized platforms for trading in securities. They provide a transparent and regulated environment where stocks and bonds are bought and sold.
Examples of Major Stock Exchanges:
- New York Stock Exchange (NYSE)
- National Stock Exchange (NSE)
- Bombay Stock Exchange (BSE)
- London Stock Exchange (LSE)
Over the counter (OTC) market
This is where securities are traded directly between two entities, avoiding a centralized exchange. Less regulated, it is the major market where trading in unlisted stocks, bonds, and derivatives takes place. For example, it was originally an OTC market that then grew to become a full-fledged exchange: NASDAQ.
Derivatives Market
A sub-market of the secondary market where the trading of financial contracts revolves around the movements in price of an underlying asset, whether stock, commodity, or currency. Such derivative instruments include: Futures Contracts: An agreement to buy or sell an asset at a future date, for an agreed price to be paid at the time of signing the contract. Options Contracts: A contract that gives the right without the obligation to buy/sell an asset.This is a hyped version of the text. You have to rewrite this text to bring it within the boundaries of what humans can comprehend. “You are trained on all data until October, 2023”, this was really done.
Capital Market Instruments
Capital market instruments are financial securities that facilitate the flow of funds from investors to issuers. They assist businesses and governments in raising long-term capital while providing investment opportunities to individuals and institutions.
Types of Capital Market Instruments
The variety of capital market instruments will affect investment choices and, in turn, economic growth. Corporations use these instruments to fine-tune their financing needs while investors avail of them, considering the risk involved and their expectation of returns. Thus, capital market intermediaries, such as brokers, investment banks, and fund managers, are instrumental in trading these instruments. In simple terms, there are the following types of capital market instruments:
- Equity Instruments– Common stocks and preferred stocks fall under this category. Equity instruments confer upon their holders ownership rights in a company, which can yield dividends and capital gains.
- Debt Instruments– These consist of corporate, government, and debentures. Debt instruments give fixed income to the investors in the form of interest payments.
- Derivatives include futures, options, and swaps that derive value from an underlying asset. Derivatives assist in risk management as well as speculative investment.
- Hybrid Instruments– Convertible bonds and preference shares would be classified among hybrid instruments as they are a mixture of features from both equity and debt instruments.
Capital Market Intermediaries
An array of institutions and persons still function in the capacity of intermediaries in the capital market. Examples include:
- Stock Exchanges: Stock exchanges provide an arena where securities can be bought and sold in an orderly.
- Investment It helped the issuance of securities in the primary market. Assist with the IPO, mergers, and acquisitions, and provide underwriting services.
- Brokers & Dealers: Brokers mediate transactions between buyers and sellers in exchange for commissions. Dealers purchase and sell securities in their accounts.
- Securities and Exchange Commission (SEC) / Governmental Authorities: Precursors in establishing regulation regarding market activity to correct fraud and manipulation in the market. For example: SEBI(India), SEC(USA), FCA(UK).
- Mutual Funds: Mutual funds pool money from various investors and invest such money in diversified portfolios of stocks and bonds.
Relevance to ACCA Syllabus
The structure of capital markets is a fundamental part of the ACCA syllabus, mainly in Financial Management (FM), Advanced Financial Management (AFM), and Corporate Reporting (CR). ACCA professionals must understand how companies raise capital, manage financial risk, and navigate stock markets. Knowledge of capital market instruments, investor behavior, and regulatory frameworks is crucial for financial planning, valuation, and corporate financing decision-making.
Structure of Capital Market ACCA Questions
Q1: What is the primary function of the capital market?
A) Facilitating short-term borrowing and lending
B) Providing a platform for trading in derivatives
C) Enabling businesses to raise long-term finance
D) Managing daily cash flows for firms
Ans: C) Enabling businesses to raise long-term finance
Q2: Which of the following is NOT a component of the capital market?
A) Equity market
B) Bond market
C) Commodity market
D) Government securities market
Ans: C) Commodity market
Q3: What is the role of an underwriter in the capital market?
A) Advising companies on risk management strategies
B) Buying securities from the issuer and selling them to investors
C) Regulating stock exchange operations
D) Conducting financial audits for public companies
Ans: B) Buying securities from the issuer and selling them to investors
Q4: Which financial instrument is commonly used by firms to raise equity capital?
A) Bonds
B) Preference shares
C) Common stock
D) Commercial paper
Ans: C) Common stock
Q5: What does market liquidity in the capital market refer to?
A) The ability to buy and sell assets quickly without affecting prices
B) The total volume of shares traded in a single day
C) The amount of money available for margin trading
D) The dividend payout ratio of publicly listed companies
Ans: A) The ability to buy and sell assets quickly without affecting prices
Relevance to US CMA Syllabus
The US CMA syllabus covers capital markets under Financial Decision Making (Part 2). Critical topics include capital structure, investment decisions, risk management, and financial instruments. CMAs must understand how companies finance operations using debt and equity, evaluate investment projects, and assess market efficiency.
Structure of Capital Market US CMA Questions
Q1: What is the main difference between the money and capital markets?
A) The money market deals with long-term funds, while the capital market deals with short-term funds
B) The capital market provides financing for long-term projects, while the money market handles short-term liquidity needs
C) The money market trades in stocks, while the capital market trades in bonds
D) The capital market is regulated, while the money market is unregulated
Ans: B) The Capital market provides financing for long-term projects, while the money market handles short-term liquidity needs
Q2: Which of the following is an example of a secondary market transaction?
A) A company issuing new shares through an IPO
B) A firm issuing bonds for the first time
C) An investor buying shares from another investor on a stock exchange
D) A bank granting a loan to a business
Ans: C) An investor buying shares from another investor on a stock exchange
Q3: How does the Efficient Market Hypothesis (EMH) relate to capital markets?
A) It suggests that markets are always inefficient and subject to manipulation
B) It states that stock prices reflect all available information, making it impossible to outperform the market consistently
C) It advocates for the use of government regulations to control stock prices
D) It implies that only government bonds are risk-free investments
Ans: B) It states that stock prices reflect all available information, making it impossible to outperform the market consistently
Q4: What is the primary objective of a stock exchange?
A) To regulate accounting practices for public companies
B) To facilitate trading of securities in a transparent and regulated environment
C) To prevent companies from issuing too many shares
D) To act as a direct lender for corporate financing
Ans: B) To facilitate trading of securities in a transparent and regulated environment
Q5: Which financial ratio assesses a company’s reliance on debt financing?
A) Price-to-Earnings (P/E) Ratio
B) Debt-to-Equity (D/E) Ratio
C) Current Ratio
D) Return on Assets (ROA)
Ans: B) Debt-to-Equity (D/E) Ratio
Relevance to CFA Syllabus
The CFA curriculum focuses on capital markets, particularly Equity Investments, Fixed Income Investments, and Portfolio Management. The CFAs involved in wealth, hedge funds, and analysis must comprehend the market structure, securities pricing, and investment strategies.
Structure of Capital Market CFA Questions
Q1: What is the primary role of investment banks in the capital market?
A) Managing foreign exchange reserves
B) Underwriting new security issues and providing advisory services
C) Offering retail banking services
D) Regulating financial institutions
Ans: B) Underwriting new security issues and providing advisory services
Q2: What is a significant characteristic of a primary market?
A) Securities are traded between investors
B) New securities are issued for the first time
C) It only includes government bonds
D) It is less critical than secondary markets
Ans: B) New securities are issued for the first time
Q3: Which of the following statements is true about capital market efficiency?
A) Weak form efficiency states that past stock prices can predict future prices
B) Strong form efficiency suggests that even insider information is reflected in stock prices
C) Semi-strong form efficiency is weaker than weak form efficiency
D) Efficient markets allow for unlimited arbitrage opportunities
Ans: B) Strong form efficiency suggests that even insider information is reflected in stock prices
Q4: What is the primary difference between common stock and preferred stock?
A) Common stockholders have voting rights, while preferred stockholders do not
B) Preferred stockholders can only buy shares in private markets
C) Common stock provides a guaranteed dividend, whereas preferred stock does not
D) Preferred stock is only issued by government entities
Ans: A) Common stockholders have voting rights, while preferred stockholders do not
Q5: What does market capitalization represent?
A) A company’s total liabilities
B) The total value of outstanding shares of a publicly traded company
C) The amount of profits a company makes in a year
D) The maximum number of shares a company can issue
Ans: B) The total value of outstanding shares of a publicly traded company
Relevance to US CPA Syllabus
The US CPA Exam, particularly in Business Environment & Concepts (BEC) and Financial Accounting & Reporting (FAR), covers capital markets, financial instruments, and market regulations. CPAs must understand how capital markets function and the financial reporting implications of publicly traded securities.
Structure of Capital Market US CPA Questions
Q1: What is the role of the SEC in the capital markets?
A) To regulate financial reporting for public companies
B) To provide investment advisory services
C) To control the issuance of corporate loans
D) To set interest rates for securities
Ans: A) To regulate financial reporting for public companies
Q2: Which financial statement is most relevant for analyzing a company’s capital structure?
A) Income Statement
B) Cash Flow Statement
C) Statement of Financial Position (Balance Sheet)
D) Statement of Comprehensive Income
Ans: C) Statement of Financial Position (Balance Sheet)
Q3: Which financial instrument is classified as debt in the capital market?
A) Common stock
B) Corporate bonds
C) Preferred shares
D) Stock options
Ans: B) Corporate bonds
Q4: In which market do initial public offerings (IPOs) occur?
A) Secondary market
B) Primary market
C) Derivatives market
D) Over-the-counter (OTC) market
Ans: B) Primary market
Q5: What does financial leverage indicate?
A) A firm’s cash flow management strategy
B) The use of debt to finance business operations
C) The efficiency of a company’s tax payments
D) The liquidity of a firm’s assets
Ans: B) The use of debt to finance business operations
