Introduction:

If you are interested in learning about the financial world, you may have come across the term “capital market.” But what does it mean, and how does it work? Let’s understand.

What is the capital market?

Simply put, the capital market is a place where financial instruments are traded. Financial instruments are contracts that represent claims to future cash flows or ownership rights. For example, a stock is a financial instrument that represents a share of ownership in a company, and a bond is a financial instrument that represents a promise to pay back a loan with interest.

The capital market meaning is essential for two main reasons: raising funds and allocating resources.

Types of Capital Market

Now that you know the capital market definition, let’s look at their two types.

Primary markets

It is where new securities are issued and sold to investors. That means the primary market is where businesses and governments can raise funds by selling their securities to the public for the first time. Here is a primary capital market example — when a company decides to go public and sell its shares to the public, it does so in this market through an Initial Public Offering (IPO).

The primary market involves three key parties: the issuer, the underwriter, and the regulator.

The issuer is the entity that issues and sells the securities, such as a company, a government, or an individual. The underwriter is the intermediary that helps the issuer, such as a bank, a broker, or an investment firm, to prepare, market, and sell the securities. The regulator is the authority that oversees and regulates the primary market, such as the Securities and Exchange Board of India (SEBI), the Reserve Bank of India (RBI), or the Insurance Regulatory and Development Authority of India (IRDA).

Secondary market

This is where existing securities are traded among investors. That means that investors can buy and sell securities already issued in the primary market. For example, when you buy or sell shares of a company on a stock exchange, you do so in the secondary market.

This market involves two main parties: the broker and the dealer. The broker is the intermediary that facilitates the trade between the buyer and the seller, such as a stockbroker, a commodity broker, or a forex broker.

The dealer is the intermediary that buys and sells securities for its account, such as a market maker, a hedge fund, or a proprietary trader.

Capital market instruments

The capital market instruments can be classified into two broad categories: equity and debt.

Equity instruments

Equity instruments give the investor the right to share the company's or asset's profits and losses and influence its management and decisions. Equity instruments are also known as risk capital because they have no fixed return and are subject to market fluctuations.

Some of the common equity instruments are:

• Common shares: These are the most basic type of shares that grant the investor a share of ownership in the company, as well as the right to participate in corporate decisions, receive dividends, and benefit from the growth of the company's value.
• Preference shares: These are a special type of shares that give the investor a priority claim on the company's dividends and assets in case of liquidation. However, they do not confer voting rights to the investor.
• Warrants are financial instruments that allow investors to buy a specified number of shares at a fixed price and time. Unlike common shares, warrants do not give the investor ownership or dividend rights until exercised.

Debt instruments

Debt instruments represent the debt obligations of a company, a government, or an organisation. They give the investor the right to receive fixed or variable interest payments and the principal amount at maturity. Debt instruments are also fixed-income securities, as they have a predetermined return and are less risky than equity instruments.

Some of the common debt instruments are:

• Debentures: Debentures are unsecured loans backed by the issuer's general creditworthiness rather than any specific asset or collateral. They may have distinct features, such as convertibility, redeemability, or subordination.
• Bonds: Bonds are secured loans backed by the issuer's specific asset or revenue stream, such as a project, a tax, or a toll. Different types of bonds exist, such as municipal, corporate, or sovereign.
• Zero-coupon bonds do not pay interest during their life. Instead, they are issued at a deep discount and pay the entire face value at maturity. Zero-coupon bonds are attractive to investors who want to lock in a certain rate of return and avoid reinvestment risk.

Conclusion

The capital market trades financial instruments such as stocks and bonds, which show ownership or debt. Understanding how it works can help you in your investments.

Related Articles:   How to Open a Demat Account Without a Broker | Factors to Keep in Mind While Opening a Demat account | Factors to Consider When Opening a Demat Account

Popular Stocks:  HDFC Bank share price | ICICI Bank Share Price | UPL Share Price | Tata Consumer Share Price | Divislab Share Price