Capital markets vs stock markets: Key differences explained

The financial system plays a crucial role in mobilising funds between savers and borrowers. The capital market and stock market are two key components of the financial system that allow companies to raise long-term capital. While the terms 'capital market' and 'stock market' are sometimes used interchangeably, there are some key differences between the two.

What is a capital market?

A capital market refers to the market where buyers and sellers trade financial securities like bonds, stocks, and other long-term debt instruments. It provides a platform for companies and governments to raise long-term funds. This market includes the stock market as well as the bond market.

Read More: What is a Capital Market? Its Meaning and Functions

Key features of the capital market

• It allows entities to raise long-term capital through the issue of securities like shares, bonds, debentures etc. This capital can be used for projects, expansions, mergers, and so on.
• It provides investors with investment options like shares, mutual funds, exchange-traded funds (ETFs) etc. Investors can earn returns from capital gains, dividends, interest etc.
• It facilitates the transfer of capital from entities with surplus capital (investors) to entities needing capital (companies). This results in productive use of capital.
• Key entities in the capital market include investment banks, stock exchanges, brokerages, mutual funds, insurance companies, pension funds, hedge funds, regulatory agencies like SEBI, and so on.
• The market consists of primary markets where new securities are issued and secondary markets where existing securities are traded.

In India, the capital market includes the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE) as well as the corporate bond market. SEBI is the main regulator of the Indian capital market.

What is a stock market?

A stock market refers specifically to the market where shares of publicly listed companies are issued and traded between buyers and sellers. It is a subset of the capital market. The stock exchanges provide a platform for trading shares while the indices (like Sensex and Nifty) reflect the overall performance of the market.

Key features of the stock market

• It allows companies to raise equity capital by issuing shares to the public through the primary market (IPOs). Afterwards, these shares can be traded on the secondary market.
• It provides investors an opportunity to invest in shares of companies. Investors can earn capital gains as share prices increase over time. They may also earn dividends from profitable companies.
• Share prices fluctuate based on market forces of demand and supply. It reflects investors' assessments of a company's earnings potential and growth prospects.
• Trading of shares is done through stock brokerages. Online trading accounts have made it easier for retail investors to participate.
• Oversight is done by SEBI and stock exchanges like BSE and NSE. They ensure fair play and transparency.
• Market performance is gauged through indices like Sensex and Nifty, which track prices of underlying shares. High index levels signal a buoyant market.

Key differences between capital markets and stock markets

1. Participants: The capital market has a wide range of participants like investment banks, insurance firms, mutual funds, pension funds, hedge funds etc. The stock market involves mainly retail and institutional equity investors, listed companies and stock brokerages.
2. Instruments: The capital market facilitates trading of various long-term securities like shares, bonds, debentures, derivatives etc. The stock market deals specifically in equities or company shares.
3. Breadth: The capital market encompasses the entire market for long-term capital covering equity, debts and hybrid instruments like convertibles. The stock market is limited to equities.
4. Listing: Securities in the capital market may be listed or unlisted. But the stock market deals only in securities listed on stock exchanges.
5. Risk-Return: Capital market instruments have varying risk-return profiles. But equity investments in stocks are perceived as riskier but with higher return potential.
6. Regulators: The capital market as a whole is regulated by SEBI. The stock market comes under the purview of both SEBI and stock exchanges.
7. Liquidity: Bonds generally have lower liquidity than equities. The stock market provides higher liquidity due to greater volumes.
8. Prices: Bond prices are less volatile compared to share prices that fluctuate dynamically in the stock market.
9. Ownership: Equities represent part ownership in a company. Bonds represent a creditor relationship. Stockholders have voting rights unlike bondholders.
10. Information: The stock market tends to garner greater public attention. More information is available on listed companies. Information is more limited for debt instruments.

Capital market segments

The capital market has two broad segments:

1. Primary Market: This is where new securities are issued through mechanisms like initial public offerings (IPOs). The issuers may be raising capital via equity, debt or hybrid instruments.

2. Secondary Market: Here, investors trade in existing or previously issued securities without involving the issuers. Trading occurs through exchanges and over-the-counter (OTC) markets.

The secondary market enables price discovery and liquidity for securities. It allows investors to enter and exit positions and adjust their portfolios. The market segments are interconnected - the primary market provides supply to the secondary market.

Stock market segments

The stock market also has primary and secondary segments.

1. Primary market: This is where companies float or list their shares through an initial public offering (IPO) to raise equity capital from the public. The shares are offered through investment banks.
2. Secondary market: Here, investors buy and sell shares of listed companies without involvement of the company. Trading takes place on stock exchanges (BSE and NSE).

The secondary market allows investors to liquidate their holdings and companies to enjoy continued liquidity for their shares post-listing. It enables price discovery based on demand/supply.

Capital vs. stock market indices

There are distinct indices for the overall capital market and the stock market.

• Capital market indices track the overall market covering various instruments. For instance, the Bloomberg Barclays India Aggregate Bond Index reflects the Indian bond market.
• Stock market indices like Sensex and Nifty track only listed equities. For instance, the Nifty 50 reflects the shares of 50 large Indian companies.

Different sets of indices are needed to gauge overall capital market vs stock market performance. Index levels also aid analysis of returns, risks and opportunities across asset classes.

Conclusion

The capital market and stock market play indispensable roles in mobilising capital and helping investors generate returns. While interlinked, they have some key differences in terms of breadth, components, liquidity, risk profiles and oversight. The stock market offers a specialised avenue for equity investments within the umbrella of the multifaceted capital market. Robust development of both markets is crucial for India's economic progress. However, awareness of their distinct identities and dynamics is important for market participants seeking to tap opportunities across asset classes. Their segregation into primary and secondary segments injects further nuance into understanding capital market structures.