After discussing the Important Terms in the Stock Market, we’d now be discussing the structure of the Indian Capital Market, the significance of the Indian Capital Market, and the different methods of financing.
Structure of the Indian Capital Market
What is Capital Market?
Going by the definition, a long-term financial market of an economy where long-term debt or equity-backed securities are brought and sold is known as the capital market. The capital market includes certain segments like banks, which is the first segment of the capital market, insurance industry, mutual fund, and the security market (stock market). It’s the capital market through which the corporations raise long-term capital for various purposes such as establishing industries or business expansion. The government also raises money through the capital market using various methods, such as issuing government bonds for infrastructure development and other developmental purposes. Capital markets emerged around the world during the age of industrialization and soon became a prominent way to channelize money between people or institutions who has the capital to lend or invest and those who are in need of those funds.
Types of Capital Market
The primary market is the market where new shares or securities are issued by a company in exchange for cash from an investor (who buys those securities). The primary market is also known as the ‘new issues market.’ It’s the primary market through which the government and companies obtain the funds by issuing debt or equity-based securities. Companies issue stocks and corporate bonds and the government issues government bonds, etc.
Different methods of raising funds in the Primary Market-
- IPO (Initial Public Offering)- Initial Public Offering is the event when a company issues its share in the market for the first time. In an IPO the investors can buy the securities directly from the issuing company.
- FPO (Further Public Offering)- Further Public Offering is also called follow-up public offering, it is when a listed company (that has already issued its shares through an IPO) issues additional shares after an IPO. Follow-on offerings are also known as secondary offerings.
- Rights Issue- Rights issue is used when a company wants additional funds. Through the rights issues, a company invites existing shareholders to purchase additional new shares in the company. It’s known as a ‘rights issue’ because the existing shareholders are given the ‘right’ to buy new shares before it’s offered to the public.
- Private Placement- A private placement is an alternate method of issuing or selling publicly offered security for raising capital. In a private placement, a company offers its securities to a group of specified investors or institutions such as wealthy investors, mutual funds, insurance companies, pension funds banks, and other financial institutions.
- QIP (Qualified Institutional Placement)- The QIP is also a type of private placement through which companies issues equity shares, debentures, or other types of securities to the Qualified Institutional Buyers (QIB). The QIBs are the investors who are deemed to have the required financial knowledge and are legally recognizable by the securities market regulators.
- Preferential Issue- Through a preferential issue, a listed or unlisted company can issue shares to a particular group of investors. The preferred shareholders get the dividend before the ordinary shareholders. The preferential issue is considered the quickest method to raise capital.
- Bonus issue- Through a bonus issue, a company allots additional shares to its existing shareholders for free, which may be allotted as a ‘gift’ to the existing shareholders.
The Secondary market is also called the ‘after market’ where the prevailing (previously issued) securities of companies are exchanged (bought and sold) between the investors. Once new securities are sold to the investors in the primary market, these investors sell these securities in the secondary market. And these securities are bought and sold in the secondary market. So, in contrast to the primary market, where investors buy shares directly from the issuing company, in the secondary market, investors purchase shares from other investors.
Equity shares, bonds, debentures, preference shares, treasury bills, etc are the key securities that are bought and sold in the secondary market.
Differences between the primary and secondary market
The basic difference between the primary and secondary market is when a company issues its stocks or bonds for the first time and sells these securities directly to the investors, this occurs in the primary market. Transactions in the primary market occur directly between the company and the investor.
And when these investors, who bought the stocks or bonds directly from the issuer, sell these securities to other interested investors, this transaction occurs in the secondary market. Transactions in the secondary market occur between two investors.
Pricing in the primary and secondary market
In the primary market, the prices of the shares issued are pre-determined and fixed at par value. Whereas in the secondary market, the prices of the shares changes depending on the demand and supply of the shares.
Instruments of the capital market
The instruments traded in the Indian capital market are-
The equity instrument includes stocks of companies, ETFs (exchange-traded funds), Initial Public Offerings, offer for sale, security lending and borrowing, etc.
A derivative is a product whose value is derived from the value of one or more basic variables such as an underlying asset or an index, in a contractual manner. These underlying assets include equity, forex, interest rate commodities, or any other asset. A derivative can be considered as a financial contract between two parties. Derivatives could be understood better with the ‘classic’ example of a wheat farmer. Let’s assume a wheat farmer wants to sell his harvest to a customer at a future date, to eliminate the risk of a change in price by that date. So, the farmer and the customer would enter into an agreement where the customer would promise to buy his wheat after the harvest at a pre-determined price mentioned in the contract. And whatever the price of wheat would be at that time, the customer would buy it at the same pre-determined price.
In India, the derivative is defined in the Securities Contracts (Regulation) Act, 1956–
- A security derived from a debt instrument, share, loan whether secured or unsecured, risk instrument, or contract for differences, or any other form of security.
- A contract, which derives its value from the prices, or index of prices, of underlying securities.
Types of derivatives traded in the capital market include-
- equity derivatives
- currency derivatives
- global indices derivatives
- NSE bond futures
They also consist of future contracts, call options, and put options.
Debt instruments such as corporate bonds, government bonds, mortgages, etc are assets that require a fixed payment to the investor along with a fixed interest. These debt instruments are traded in the debt market. These instruments are issued by companies in order to raise capital for financing new projects, business expansion, etc. And the government uses government bonds, which are considered the safest debt instruments, to raise capital for implementing infrastructure projects, and other developmental works. The most common type of debt instrument is bond.
Bonds represent debt. A bond is a fixed-income security, which is created through a contract called a bond indenture. These bonds put an obligation on the issuer to pay a fixed amount of interest at regular intervals, called the bond yield, and the principal amount to the investor on maturity.
The main difference between a bond and a stock is that when you buy a stock, you’re buying a share in the issuing company, whereas when you purchase a bond, you’re providing a loan to the issuing company for a fixed period of time.
However, like stocks, there are risks associated with bonds too. Though the issuer is obliged to pay you fixed interest and principal amount, if due to unfortunate circumstances, the issuer fails to pay back debt, then the bond issued would default. So, if the risk associated with the bond issued is high, then the investor would demand a higher rate of interest for risking his money. On the other hand, the lower the risk associated with the bond issued, the lower the interest rate demanded by the investor. So, generally, bonds issued by national governments, often called sovereign bonds, provide a lower rate of interest because they are usually very safe as they’re backed by the government, and it’s very unlikely that the government would default on its debt obligations.
On the other hand, the bonds issued by companies that have lower credit ratings, are associated with comparatively higher risks, and hence the rate of interest demanded by the investor is generally higher, as the investor wants better returns for risking his money.
Significance of the capital market in India
Well, as we all know that after independence, India went for ‘industry’ as its prime moving factor. So, for rapid and sustainable industrial growth, every country requires strong financial institutions for financing the industrial establishments, and this cannot be done alone by the banking sector. However, as we didn’t have the required financial institutions initially, the main responsibility for industrial financing was given to the Public Sector Banks (PSBs).
But as I said earlier, banks as the only financial institution are not enough to attain substantial and rapid industrialization. And banks at that time had a very low savings rate and lower deposits with them, which were surely inadequate. So, the Government decided to set up more Financial Institutions.
All India Financial Institutions
- Industrial Finance Corporation of India (IFCI), set up in 1948
- Industrial Credit and Investment Corporation of India (ICICI), set up in 1955
- Industrial Development Bank of India (IDBI), set up in 1964
- Small Industries Development Bank of India (SIDBI), set up in 1990
- Industrial Investment Bank of India (IIBI), set up in 1997
That’s all for the Structure of the Indian Capital Market.
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