What is a Capital Market? Its Meaning and Functions

A capital market is a platform that allows individuals, businesses, and governments to buy and sell financial instruments. Organisations can sell various securities to retail investors and financial institutions like banks to raise capital. So, the capital market acts as an essential link between investors and organisations looking to obtain funds. To understand what a capital market is is in detail, you can read this article.

Key Highlights

• A capital market refers to a physical or virtual place where different financial instruments are traded, allowing companies and governments to obtain funds.
  

• Stock exchanges facilitate the functioning of capital markets. Venture capitalists, investment banks, and brokerage houses act as intermediaries.
  

• The regulatory bodies monitor all the transactions in the capital market.
  

Capital Market Meaning

The capital market definition refers to the platform where financial products are traded. A few examples of capital markets are stock market, bond, and currency markets (forex). They make it easier to buy and sell financial instruments like zero-coupon bonds, preference shares, debentures, and equity shares.

Capital markets support organisations by offering a platform for obtaining capital to run companies or increase wealth. Capital markets typically offer financial instruments like ownership shares in a firm- stocks or other debt assets like bonds, which also carry interest.

How Do Capital Markets Work?

In simple terms, capital markets operate by bringing together investors who have money with organisations that need funding. When companies or governments want to raise capital, they issue financial instruments like stocks or bonds. These are then bought by investors—either individuals or institutions—who expect a return on their investment.

The market functions through a network of exchanges, intermediaries, and regulators to ensure that buying and selling happen smoothly and transparently. Prices are determined based on supply and demand, and investors can choose where to put their money based on their risk appetite and financial goals.

Types of Capital Markets

Primary markets and secondary markets are the two main types of capital markets.

Primary Markets

Companies offer new shares or bonds in the primary market. Here, companies and governments look for fresh funding. It's also known as the 'New Issues Market'.

Debt and stocks are the two main financial instruments traded in primary capital markets. New stocks are issued in the market through an initial public offering or IPO. It's the process of raising money by selling a portion of the ownership in a company to the general public. On the other hand, bonds are debt securities that allow a company or government to obtain funds for a specified period.

Secondary Markets

Securities and bonds are traded on the secondary capital market. The trading takes place through exchanges like the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). The secondary market is used by investors to raise money to invest in stocks and other securities like bonds. It is regulated by the Securities and Exchange Board of India (SEBI), which oversees the operations of stock exchanges, intermediaries, and market participants. SEBI's regulations aim to promote transparency, protect investor interests, and maintain market integrity.

Commonly Traded Instruments in Capital Markets

Capital markets offer a range of financial instruments that cater to different investor needs. Each instrument serves a unique purpose, be it raising funds, earning returns, or managing risks. Some of the most commonly traded instruments include:

• Stocks: Represent ownership in a company and give investors a claim on its profits.

• Bonds: Debt instruments issued by companies or governments to raise money, usually with fixed interest payments.

• Debentures: Similar to bonds but typically unsecured, meaning they aren’t backed by specific assets.

• Mutual funds: Pooled investment vehicles managed by professionals, ideal for investors looking for diversification.

• Derivatives: Financial contracts like futures and options, whose value is based on an underlying asset such as a stock or index.

These instruments allow participants to invest, grow capital, and manage risk, making them essential to the smooth functioning of capital markets.

Key Elements of a Capital Market

Capital markets rely on a few key elements to function efficiently. These components work together to ensure smooth transactions, fair pricing and investor confidence. The main elements include:

• Investors: Individuals or institutions that provide funds by buying securities.

• Issuers: Companies or governments that raise money by issuing stocks or bonds.

• Intermediaries: Entities like brokers, investment banks, and mutual fund companies that connect investors with issuers.

• Regulators: Bodies like the Securities and Exchange Board of India (SEBI) that oversee market operations and protect investor interests.

• Exchanges: Platforms such as the NSE and BSE where securities are listed and traded.

Each element plays a specific role in maintaining transparency, efficiency, and trust within the capital market.

Functions of Capital Markets

The following are the functions of the capital market:

• Links investors and borrowers: The role of capital markets is to act as a middleman between those who have extra money and those who don't.

• Formation of capital: An essential component of the capital market is capital formation. It provides funds on time to meet the financial needs of various economic sectors.

• Controls security prices: Capital markets promote the stability and systematic pricing of securities. It ensures that the securities are traded fairly and transparently. The borrower is charged a standard interest rate or a minimum interest rate. As a result, securities prices in the economy stabilise.

• Offers opportunities to investors: The capital markets provide a variety of financial instruments to meet the demands of each investor. Although there are some risks, investors can obtain a better rate of return by investing in the capital market.

• Reduces transaction time and cost: The capital market ensures the entire trading procedure is expedited owing to complete automation, streamlined, and costs less. Capital liquidity: On the capital markets, investors can sell their assets to a third party for cash.

Capital Market vs Money Market

Conclusion

The capital market is a financial platform where buyers and sellers trade securities like stocks and bonds. It helps in making available funds to those organisations who need capital. It also gives companies access to funds for expansion and enables governments to finance projects. Moreover, this type of market also offers investors diverse opportunities to grow their wealth. Hence, the capital market plays an essential role in the financial market, and overall economic development.