Capital market is a market where buyers and sellers engage in the trade of financial securities like bonds, stocks, etc. The trading is undertaken by participants such as individuals and institutions. Capital markets help channelize surplus funds from savers to institutions which then invest them into productive use. Generally, this market trades mostly in long-term securities.
Capital market consists of primary markets and secondary markets. Primary markets deal with trade of new issues of stocks and other securities, whereas secondary market deals with the exchange of existing or previously-issued securities. Another important division in the capital market is made on the basis of the nature of security traded, that is as stock market and bond market.
The capital market has two interdependent and inseparable segments, Primary market & Secondary (stock market).
Primary Market –
The primary market is where companies float shares to the general public in an initial public offering (IPO) to raise capital. It issues new securities on an exchange for companies, governments and other groups to obtain financing through debt-based or equity-based securities.
Primary markets are facilitated by underwriting groups consisting of investment banks that set a beginning price range for a given security and oversee its sale to investors. Once the initial sale is complete, further trading is conducted on the secondary market, where the bulk of exchange trading occurs each day.
Secondary Market –
The secondary market is where investors buy and sell securities they already own. It is what most people typically think of as the “stock market,” though stocks are also sold on the primary market when they are first issued. Stock exchange is a place where shares of public listed companies are traded.
Instruments of capital market:
Classification of instruments can be mainly classified into 3 categories
Pure, Hybrid and Derivatives.
Pure instruments –
A pure discount instrument is a type of security that pays no income until maturity; upon expiration, the holder receives the face value of the instrument. The instrument is originally sold for less than its face value (at a discount) and redeemed at par.
Hybrid Instruments –
A hybrid security is a single financial security that combines two or more different financial instruments. Hybrid securities, often referred to as “hybrids,” generally combine both debt and equity characteristics. The most common type of hybrid security is a convertible bond that has features of an ordinary bond. But it is heavily influenced by the price movements of the stock into which it is convertible.
A derivative is a financial security with a value that is reliant upon, or derived from, an underlying asset or group of assets. The derivative itself is a contract between two or more parties. And its price is determined by fluctuations in the underlying asset. The most common underlying assets include stocks, bonds, commodities, currencies, interest rates and market indexes.
Derivatives can either be traded over-the-counter (OTC) or on an exchange. OTC derivatives constitute the greater proportion of derivatives and are not standardized. Meanwhile, derivatives traded on exchanges are standardized and more heavily regulated. OTC derivatives generally have greater counter-party risk than standardized derivatives.