Companies and industries are known to raise short-term funds through the money market. When the companies need funds for the long term then the capital market comes into play. Therefore, the part of the financial market which deals with shares, bonds, and other long-term investment tools is called the capital market. Capital markets are of two types- primary and secondary.
Capital Market: the Definitions and Objectives
The financial market, to begin with, is a marketplace where financial assets such as shares, bonds, debentures, currencies, and derivatives, etc are created and traded. It plays an important role in the country’s economy by allocating limited resources to where it is required.
The financial market is of two types- the capital market and money market. The capital market involves financial instruments and commodities that can be treated as long-term security. The maturity period of long-term security has to be at least more than one year.
Money market and capital market both have the same function. They serve as a link between the investors and the wealth creators. The funds of the capital market are used for purposes that are productive and creative for the long term.
An important function of the capital market is to provide easy transactions for both the investors and the companies involved. Both of these parties should be able to find each other easily and the legal proceedings should also go on smoothly.
Types of the Capital Market
The primary market is the most important type of capital market. This type of market is called the new issue market. The main purpose of this market is to deal with new securities i.e. the securities that are issued to the investors for the first time.
Most important function of the primary market is the formation of capital for companies, government, institutions etc. It helps the companies find investors who are willing to invest in their company's project or expansion.
Some Methods of Raising Funds
The companies raise money in the primary market through securities such as shares, debentures, loans and deposits, and preference shares, etc. Let us take a look at the various methods of how new securities are floated in the primary market.
1] Offer through Prospectus
This method involves public issues. It is widely used in the public method to raise funds. In this method the companies invite the investors to invest in their company through an advertisement (known as a prospectus).
After issuing a prospectus the public starts investing in shares, debentures etc. According to the response, shares will be allotted to the public. In case the subscriptions are high, allotment is done on a pro-rata basis. The company shares can be sold to the public. Generally it hires brokers or underwriters.
2] Private Placement
This method offers investment opportunities to select some individuals. This is preferred as the public offers are expensive. They provide Investment opportunities to some selected individuals.
So, when the company sells its shares to any financial institution like banks, insurance companies and so on it helps in raising funds quickly, economically and efficiently. Such a company neither sells nor offers the securities largely to the public.
3] Rights Issue
Often when a company wants to expand or need additional funds, it generally first turns to the current investors. Thus, the current shareholders have an opportunity to invest more in the company. They can buy new shares before the public is given a chance.
The allotment of new shares is performed on a pro-rata basis. If the shareholder chooses to let go of this offer then the public is allowed to purchase the shares. If the shareholder wants to purchase the shares then they will acquire more shares.
This means Electronic Initial Public Offer. When a company is willing to offer its shares to the public it can opt for online offers. The company and the relevant stick exchange sign an agreement known as the e-IPO.
SEBI introduced this system in India 3 years ago. This makes the entire process of IPO faster and more efficient. The company will have to work with brokers to accept the received applications. Apart from this, a registrar must be appointed to the issue.
The other type of market apart from the primary market is the secondary market. This market is more commonly known as the stock market of the stock exchange. This market is inclusive of securities in the form of shares, debentures, bonds, bills etc and these are bought and sold between parties.
The main difference between the primary and the secondary market is that primary markets only deal with new securities that were issued. On the other hand, the secondary market is for trading in existing securities. There are no fresh issues in the dealings of the secondary market.
The trading of securities takes place in a highly regulated and legalized market under strict rules and regulations. This is to make sure that the investors can trade without the fear of scams. During the last decade the technological advancements have resulted in a great boon for the secondary capital market.