FINANCIAL MARKET OPERATIONS

(UNIT-3)
CAPITAL MARKET
(PART-1)

1. INTRODUCTION
Hello viewers,

Welcome to the lecture series on Financial Market Operations. Today we

are going to take up Unit -3 and we are going to discuss about capital
markets.

Capital Market is one of the components of Financial Markets and we are

going to learn about its composition and structure under this lecture.

Our learning objective is:-

• To acquaint the students with the working of financial markets in

India.

• To understand the structure and composition of Capital Market

• To learn the roles and function of stock exchange

• Listing procedure and legal requirement as well as

• Public issue – their Pricing and Marketing

When we are learning these objectives we will have an insight of capital

market in detail.

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 2. CAPITAL MARKET
Now let us understand what capital markets are?

 The market where investment instruments like bonds, equities and

mortgages are traded is known as the capital market.

 The primal role of this market is to make investment from investors

who have surplus funds to the ones who are running a deficit.

So let us analyze this definition. Capital Market is a form of market and

the capital market instruments are bonds, equity and mortgages. So
where any financial asset is being used for raising the funds, such market
is known as capital market. Let us take up an example and understand it
in a layman language

XYZ co. is going to start up a new business and it is in need of certain

fund. That fund can acquired fund from the public rather than going to
any financial institution. If the investment is taken from the public, the
company is going to issue shares. So those who are investing into the
company their money they are going to get equities and in turn the
company will get money from those who are having surplus because the
company is having the deficit fund which they have met up by going for
the issue of shares and public at large subscribe those shares and give
their contribution to the one who needs it and in turn they get return for
their investment.

So, this is the basic premises of capital market that the investment from
investors will move to one who is getting the shortage of fund again it is
also a channelization of the fund or the surpluses into the investment.

Let us highlight the nature of capital market. The nature of capital

market is brought out by the following facts:

 It Has Two Segments

 It Deals In Long-Term Securities

 It Performs Trade-off Function

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 It Creates Dispersion In Business Ownership

 It Helps In Capital Formation

 It Helps In Creating Liquidity

 The capital market offers both long term and overnight funds.

So, one by one let us analyze.

It has two segments because it is dealing with issue of new shares as well
as their trading of the shares. So Primary and secondary markets are also
part of it.

It performs trade off function that means trading is being done where the
tradeoff is being ascertained by the purchasing and selling of the scripts
and securities

Dispersion in Business Ownership means the Ownership and Management

are being separated those who are investing the funds into the business
are owners of the business however the company is the acquirer of the
funds.

It helps in capital formation as the savings are being channelized into the
investments and in turn the idle funds are being transformed into the
investments which are getting their returns on it.

And the liquidity is also being generated out of the funds which are being
released from those who are having them extra to those who need them.

The capital market offers both long term and overnight funds.

The different types of financial instruments that are trade in the capital
markets are

 Equity instruments that mean equity shares, equity instruments are

those instruments which gives the voting right to the investors and the

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amount of the share which an investor is holding he has been owner or
ownership to that extent.
 Credit market instruments such as debts,
 insurance instruments,
 Forex that means foreign exchange instruments, derivatives,
options, swaps they can be there.
 Hybrid instruments: they can be mixture of equity and debt
financing
 Derivative Instruments. Like options, commodity related
derivatives.

Basically capital market is having instruments which are focused on the

equity and debts.

The capital market is a market for financial assets which have along or
indefinite maturity.

Here, financial assets mean those assets which when used, are used in
generation of any revenue and they are being used in the production like
share capital.

Share capital is financial asset because when share is being issued, the
amount is being used in the acquisition of long –term assets or for working
capital. And in turn the investor gets return out of it. So here in the
capital market the financial assets have a long or indefinite maturity that
means unlike the money market which meets the short term funds
requirement; capital market is dealing with financial assets which have a
long or indefinite maturity. Generally, it deals with long term securities
which have a maturity period of above one year. Capital market may be
further divided into three, namely:

1. Industrial Securities Market

2. Government Securities Market and

3. Long-term Loans Market.

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So here we can analyze that there are certain differences between
capital market and money market. Money market is concerned with the
funding that is borrowing and accepting of deposits loans and interest
spread is the main functioning over there. While in the capital market the
primary issue of shares as well as secondary trading of the shares is being
taking place here. The maturity period of the securities or investments
are low in the money market it varies from one day to 14 days or can
extend up to one year in the case of money market while in the case of
capital market the maturity can be for indefinite period and generally
more than 1 year.

So again we have certain segments of (money) capital markets they are

known as

. Industrial Securities Market

2. Government Securities Market and

3. Long-term Loans Market.

Let us analyze these segments one by one

3. INDUSTRIAL SECURITIES MARKET

As the very name implies, it is a market for industrial securities, namely:
what can be these securities

(i) Equity shares

(ii) Preference shares and

(iii) Debentures or bonds.

So, Sources of financing would be equity shares. Equity shares are those
shares which give voting right to the subscriber. It is the smallest part of
the share capital of the company which a shareholder has and he is
having the right to dividend to the extent of his shareholding into the
business of any enterprise. Preference shares are those shares which are
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having preferential rights at the time of liquidation; preferential
payments are made to the preference shareholders. There can be
redeemable or irredeemable preference shares. Debentures is the
acknowledgment of the debt by the company that means equity and
preference shares are the part of the share capital of the company while
debentures would be the part of long –term liabilities or long- term loans.
Debentures and bonds are considered to be the long term loans which
company has taken from any investor.

It is a market where industrial concerns raise their capital or debt by

issuing appropriate instruments. It can be further subdivided into two.
They are

a. Primary market or New Issue Market,

b. Secondary market or Stock Exchange

So under industrial securities those securities which fulfills the

requirements of capital or debt of a company would be dealt in and
there can be two types of securities market they are

Primary Markets and secondary markets.

So we will move ahead and learn what we mean by primary market and
secondary market

Primary Market: It is that market in which shares, debentures and other

securities are sold for the first time for collecting long-term capital. This
market is concerned with new issues. Therefore, the primary market is
also called NEW ISSUE MARKET.

Analyzing it, we can say that when first time any share comes into the
market, they will be dealt in the primary market so the subscription to
the new issue or the launching of the IPOs will be in the primary market.
Primary market is a market for new issues or new financial claim Hence,
it is also called new issue market which we have right now discusses. The

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primary market deals with those securities which are issued to the public
for the first time.

In the primary market, borrowers exchange new financial securities for

long-term funds. Thus, primary market facilitates capital formation.

There are three ways by which a company may raise capital in a

primary market. They are

(i) Public issue

(ii) Right issue and

(iii)Private placement

Public issues are those shares which are those shares which are being
issued to pubic or a new company is going to issue their first time share
or an already existing company coming up with new issues of the shares
they can be public issues.

Right issues are those issues which are being given to the already existing
shareholders, they are given certain rights. For example, if a shareholder
is having 5 shares he will be giving 3 new shares. So the exchange ratio or
right issue ratio is being decided for the issue of shares.

Private placement is the method of selling shares privately to any

institution or any group of people.

Let us highlight Features of Primary Market

 It Is Related With New Issues

 It Has No Particular Place

 It Has Various Methods Of Float Capital:

Following are the methods of raising capital in the primary market: They
are further enhancement of 3 methods we have already learned that is
public issue, offer for sale and private placement. Here also

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 i) Public Issue

ii) Offer For Sale

iii) Private Placement

iv) Right Issue

v) Electronic-Initial Public Offer

First time whenever a security will come, it will be sold or come in

primary market then the further dealings will be in secondary markets.

4. SECONDARY MARKET
So let us understand the secondary market

Secondary Market is a market for secondary sale of securities. In other

words, securities which have already passed through the new issue
market will be dealt in secondary market. Here secondary sale of
securities means that first time it is being launched in the primary market
now from the one who is having the security will sale or further sale
those securities in a market known as secondary market and the general
mechanism of buying and selling the secondary security is stock
exchange.

 Generally, such securities are quoted in the stock exchange and it

provides a continuous and regular market for buying and selling of
securities. (so they) Quoted here means they are listed in the stock
market and they are priced over there by a mechanism and they are
being sold on stock market and it is being done on a regular and
continuous basis.

 This market consists of all stock exchanges recognized by the

Government. And in India there are 23 stock exchanges which are
working in the form of secondary market for buying and selling securities

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The transactions of the secondary market are generally done through the
medium of stock exchange.

 The chief purpose of the secondary market is to create liquidity in

securities. Liquidity here means securities are being readily converted
into cash because whenever there is need of cash we can go and sell
those securities in the stock exchange and when there is surplus fund we
need to invest we can buy the securities. So there are certain trends at
the time of recession they can be more buying of securities, when the
market is on upward side, selling would be there. So again an equilibrium
points come and in this way stock exchange work. So in this way,
secondary market basically fulfills the need of liquidity for an individual
or any enterprise.

 If an individual has bought some security and he now wants to sell

it, he can do so through the medium of stock exchange to sell or purchase
through the medium of stock exchange requires the services of the broker
presently, there are 24 stock exchanges in India. Buying and selling would
be transformed or could be channelized through a broker. Broker is a
person who has been registered with stock exchange and who is having
membership with the stock exchange and via broker these dealings will
be done in stock exchange.

Important Features of Secondary Market

1. It Creates Liquidity

2. It Comes After Primary Market

3. It Has A Particular Place

4. It Encourage New Investments

Unlike the primary markets, where there is no space or certain

particular place, the secondary market transactions will be done at a
particular place which is known as stock exchange and of course, it
will give way to new investments in the economy.

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 5. GOVERNMENT SECURITIES MARKET
Now coming to the second important parameter of capital market It is
Government Securities Market. First one was Industrial Securities market
in which the requirement of capital and debt were met out. Now it is
Government securities market. Let us understand it

Government Securities Market

It is otherwise called Gilt-Edged securities market. It is a market where

government securities are traded. In India there are many kinds of
Government securities – short term and long term. Long-term securities
are traded in this market while short term securities are traded in money
market

So Government Securities or called Gilt-Edged securities will be dealt in

both types of market- the money market or the capital market
depending upon their maturity period.

Long-term Loans Market is the third segment of capital market.

Long-term Loans Market

Development banks and commercial banks play a significant role in this

market by supplying long term loans to corporate customers. Long term
loans market may further be classified into –

(i) Term loans,

(ii) Mortgages and

(iii) Financial Guarantees markets.

So the third segment of capital market is Long term loan market. Here
what happens that development banks, development banks are those
banks which are established for some specialized sectorial development
such as IDBI, IFCI, ICICI and some commercial banks. These banks play a
significant role in supplying long term loans to corporate customers. That
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means the big entities or big corporate entities when they are in need of
funds, those needs will be fulfilled by long term loan markets under
capital market and such loans can be term loans, Mortgage loan or
financial guarantee markets.

6. CAPITAL MARKET RISK

The next aspect related to the capital market is the Capital Market
Risk. Let us understand what sorts of risk are involved in the capital
market.

1. CAPITAL MARKET RISK

 Investment in long term financial instruments is accompanied by

high capital market risks. Since there are two types of capital markets-
the stock market and the bond market. So risks are present in both the
market that is in the stock market there will be risk and in the bond
market also there will be risk associated with it.

Risk in the Stock Market

 Stock prices keep fluctuating over a wide range unlike the bank
deposits or government bonds because bank deposits and government
bonds are risk free investment

 The efficient market hypothesis shows the effect of fundamental

factors in changing the price of the stock market.

 The Efficient Market Hypothesis shows that all price movements are
random whereas there are plenty of studies that reflect the fact that
there is a specific trend in the stock market prices over a period of time.
That means the slump, boom, these recessions, then revival these phases
come at a specific trend for certain securities and it can be random also
depending upon the market conditions. So there are two segments of
hypotheses.

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 Research has shown that there are certain psychological factors
that shape the stock market prices.

 Sometimes the market behaves illogically to any economic news.

This news can be rise in the market prices or interest rate and so market
moves accordingly and there are fluctuation in prices the stock exchange
may move up or may move down depending upon the psychological
impacts of those news.

 The stock market prices can be diverted in any direction in response

to press releases, rumors and mass panic.

 The stock market prices are also subject to speculation.

Speculation means there are certain guess works which are being done.
In the short run the stock market prices may be very volatile due to the
occurrences of the fast market changing events.

Another aspect is Risk in the bond market

 Capital market risk in the bond market arises due to interest rate
changes. There is an inverse relationship existing between the interest
rate and the price of the bond. That means if interest rate increases, the
price of the bond is going down, if interest rate falls down, prices would
be increases. Hence the bond prices are sensitive to the monetary policy
of the country as well as economic changes.

7. STOCK EXCHANGES
Now let us have an overview about the stock exchanges subject to the
government supervision and control they work. Basically they are being
governed by two acts: SEBI and Securities Contract and Regulation Act
(SECRA) 1956. Total numbers of stock exchanges are 23 there are two
national stock exchanges in India one is BSE that is Bombay Stock
Exchange and another is NSE that is National Stock Exchange. BSE was set
up in 1857 in fact oldest in Asia and NSE was set up in 1993 has 70% share
of the total trading. Out of 21 regional stock exchanges, 15 stock

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exchanges reported NIL transactions. NSE is the harbinger of reforms in
the capital market.

So this is the scenario of the stock exchanges in India. That there are
majorly two stock exchanges – BSE and NSE and NSE is capturing 70%
share of the total trading and it is bringing up the reforms in the capital
marking.

8. SUMMARY
Now students we are going to summarize our discussion on capital
markets. We have learnt that capital markets are those markets in which
financial assets are being dealt which are of long-term nature and there
are certain instruments under capital markets that are equity funds,
preference shares, debts instrument, foreign exchange instruments. And
under capital market there are two types of markets which are primary
market and secondary market where issues of shares are done. When
shares come first time into the picture primary market is a place where
dealing will be done and where regular buying and selling is done through
a broker at a particular place that place is known as secondary market.
We have also learned the position of stock exchanges in India that there
are two main national stock exchanges that is NSE and BSE and we have
insight of the market share of NSE and BSE. With this we are ending up
our session of today. Hope there was a happy learning about the capital
markets.

Thank you

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