Abstract market is broadly categorised in to two categories

Abstract

Capital market in
Simple terms can be defined as the platform that provides the capital in terms
of money to the industrialist and entrepreneurs for short as well long terms.

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The capital market is a
network of specialized financial institutions, series of mechanism, processes
and infrastructure that, in various ways facilitate the bringing together of
suppliers and users of medium to long term capital for investment in economic
developmental project.1

The capital market has
a great significance in promoting the Economic development in a   country as it facilitates and promotes the
economic growth by mobilizing resources available with the investor and
diverting them towards a productive channel. Various functions of the Capital
Market can be seen as a Link between savers and investors, encourages saving,
encourages to investment, and stabilises the security prices.

In a growing Economy,
it can be said that the main role of a capital markets is to make funds
available for investors undertaking long- term projects at a competitive cost
of capital.

The capital market is broadly
categorised in to two categories namely Primary and Secondary markets. The difference between
the  primary capital
market and the secondary capital
market is that in the primary market, investors buy
securities directly from the company issuing them, these includes securities in
the form of stocks, issued as IPO, FPO, bonds etc issued directly by the
company while in the secondary market, investors trade securities among themselves,
on a common platform, known as the Stock exchange and the company whose security
is being traded does not participate in these transactions.

 

 

 

 

 

 

Introduction

The economic growth of
a country in the modern economic system is dependent upon an efficient financial
sector that pools domestic savings as well as mobilises foreign capital for
productive investment.

The financial sector can be stated as
the interaction of markets and all of its constituents, within a regulatory framework.
This interaction is usually related to lending and borrowing of money in both
long and short terms. This process of lending and borrowing is accomplished
with the help of financial
intermediaries which includes banks and other financial
institutions which acts as a link between households, firms and governments in
aiding the transfer of funds from savers to borrowers, for consumption and
investment purposes.

 The importance of the capital market can be assessed
with the help of the question as to Why do we need the capital markets when the
task may be accomplished with the help of already existing banking institution?

The answer to this
question is that, most of the banks in an economy are willing to lend the money
for short-terms. And there are only a few banks that provide long-term financing
and they are usually not equipped with either human or financial resources to
handle the financing of variety of capital requirement needs for long-term
development projects, especially those related to education, agriculture, and
other social development projects.

Secondly, most of these
banks which provide long-term capital are interested mainly in projects which
are less risky and which generate greater cash flow. Thirdly, these banks are
willing to undertake projects that are deemed profitable as these banks are accountable
to their shareholders and creditors and are under pressure to show profits on
their income statements and this explains their aversion to the risk inherent
in long-term projects.

Traditionally, the banking
industry is not known for its risk-taking attitude whereas on the other hand, unlike
the banking industry the capital markets institutions are not liable to
investors in the case of such risks and defaults. This “Non-Liability” to
investors is one of the major advantages of the capital market.

 

 

Instruments
of Capital Market

The capital market, as described above, is that sector
of the financial market which deals with the channelling of funds from the
surplus to the deficit units. This process of transfer of funds is done
through instruments, which are documents or certificates, evidencing the
investments. The instruments being traded in the capital market are:

1.      Debt
Instruments

A debt instrument is used by the companies or
governments to generate funds for the projects that are capital-intensive in
nature. It can be obtained from the primary as well as the secondary
market. The relationship amongst the lender and the borrower in this form of
instrument is that of a borrower and creditor and thus, does not imply
ownership of the lender in the business of the borrower. 

The contract is for a specific duration and
interest is paid at specified periods as stated in the trust contract. The
principal sum invested, is repayable at the expiration of the contract period
with interest either paid quarterly, semi-annually or annually. The
interest stated in the instrument may be either fixed or flexible. The Investment
in these instruments is, mostly, risk-free and therefore yields a lower return
as compared to the other instruments traded in the same market. Investors
in this category get top priority in the event of liquidation of a company.

The instrument is issued by The Union Government,
are called a Sovereign Bond, the instruments issued by A state government
are called State Bond; The instruments when issued by A local government
are called as Municipal Bond; and when such a instrument is issued by
A corporate body or a Company, they are called as Debentures, Industrial
Loan or a Corporate Bond.

2.    Equities
or Common Stock

These instruments can be issued by companies only
and can be obtained either in the primary market or the secondary market. The
contract between the issuer and the purchaser of equities or Stock stands in
perpetuity unless sold to another investor in the secondary market. Purchase
of this instrument translates to ownership of the business as the investor or
buyer possesses certain rights and privileges such as to vote, to participate in
the general meetings, receive dividends and hold position in the company. The
basic difference between debt instrument and equity is that whereas the
investor in debts is entitled to interest which must be paid, the equity holder
is entitled to receive dividends which may or may not be declared.

The risk factor in case of equities is high and
therefore when successful yields a higher return. However the holders of
these instruments are ranked bottom in the list of preference in the event of
liquidation of the company as they are considered as owners of the company.

3.      Preference
Shares

Preference shares capital, with reference to any
company, means that part of the issued share capital of the company which
carries or would carry a preferential right with respect to the payment of
dividend or repayment, in the case of a winding up or repayment of capital.

These instruments possesses the characteristics of
equity in the sense that when the authorised share capital and paid up capital
are being calculated, they are added to equity capital to arrive at the total however
the Preference shares are also treated as a debt instrument as they do not
carry any voting rights and the payment of dividends is structured like payment
of interest i.e. either a fixed percentage or amount.

Preference shares can be of the following types

a)     
Convertible Preference Shares: In this
case, upon maturity of the instrument, the principal which is to be returned to
the investor is converted in to equity shares even though dividends in the
nature of interest, had earlier been paid

b)     
Redeemable and non-convertible: In this
case the holder is entitled to only sell his holding in the secondary market as
the instrument will also not be converted to equities. At the maturity of the
instrument the principal sum is repaid and the instrument is redeemed.

4.    Derivatives

These are instruments that derive their value from
other securities, which are referred to as underlying assets. The price,
risk factor s and function of the derivatives depend on the underlying assets
as whatever affects the underlying asset also affects the derivatives. The
derivative might be an asset, index or even situation.   Derivatives
are mostly common in developed economies.

Some examples of derivatives are:

Mortgage-Backed
Securities (MBS)
Asset-Backed
Securities (ABS)
Futures
Options
Swaps
Rights
Exchange
Traded Funds or commodities

Role
of Capital Market in the development of an Economy

The Capital market
plays an extremely important role in promoting and sustaining the growth of an
economy as it acts as an important and efficient conduit to channel and
mobilize funds to enterprises, both private and government, while playing  a critical role in mobilizing savings for
investment in productive assets, with a view to enhancing a country’s long-term
growth prospects, and thus its role as a major catalyst in transforming the
economy into a more efficient, innovative and competitive marketplace within
the global arena cannot be denied.

In addition to resource
allocation, capital markets also acts as a medium for risk management by
allowing the diversification of risk in the economy.

A well-functioning
capital market also improves the quality of information available in the market
as it encourages the adoption of stronger corporate governance principles, thus
supporting a trading environment, which is founded on transparency, fair play and
integrity.

Capital market has also
played a crucial role in supporting periods of technological progress and
economic development throughout history. The liquidity of the capital market
instruments makes it possible for the borrowers to obtain financing for
capital-intensive projects with long gestation periods which was evident during
the industrial revolution in the 18th century and also continues to apply even
as we move towards New more developed Economy.

The Capital market make
it possible for companies to give shares to their employees in the form of
Employee Stock Option Purchase (ESOPs), provides a currency for acquisitions
via share swaps. Along with providing an excellent route for disinvestments to
take place.

A
good, efficient and performing Capital Market

A good capital market
can be characterized as a market which aids in timely settlement of the
transactions, which is regulated to rule out the foul play and is free from malafide and adverse manipulation,
whereas an efficient market along with the characteristics of a good market also
encourages the investors to enter the market to invest their savings by
providing varied avenues for investing as per the desire of the investors. A
performing Capital Market is the one that performs optimally with minimum hindrances
and both the investors as well as the borrowers are able to derive maximum
benefits from the market in terms of finances and returns and ultimately
contribute towards industrial and Economic development.

Conclusion

The existence of deep,
broad and performing capital market is absolutely crucial in spurring the
growth a country. An essential imperative for India for a long time has been to
develop its capital market to provide the companies and other business entities
an alternative source of funding and in doing so, achieve more effective
mobilisation of investors’ savings. The

Capital market also
provides a valuable source of external finance. Even after independence, for a
long time, the Indian capital market was considered too small and
underdeveloped and risky to warrant much attention. However, this view was changed
rapidly after 1992 i.e. after the advent of Securities Exchange Board of India (SEBI)
as the regulator as well as the leader of the financial market. As a result of
this, vast amounts of both international and domestic investment have poured
into our markets over the last decade. The Indian market is no longer viewed as
a static universe with high risk and default potential but as a constantly
evolving platform, one that provides attractive finance opportunities to the
industry and equally attractive opportunities to the investing community.

1 Al- Faki-2006

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