There are many instances when we wonder where to invest our hard-earned money to generate passive income for our dear ones. If you want to invest long-term without bothering about the ups and downs of the economic trends, then investing in the Capital Market might be a good choice. 

Now, “What is Capital Market?”, “How does Capital Market work?” and “What are types of capital market?”. We’ll tackle your queries through this article one by one to give a more profound overview of capital market workings, their classifications and functions.

Understanding Capital Markets

A capital market is a giant financial marketplace where long-term investments are traded. This includes buying and selling stocks, bonds, and other financial assets. It essentially connects businesses and governments needing funds for projects with investors looking to grow their wealth. In short, it’s like a bridge between those with money and those needing capital for growth.

Understanding Capital Markets: Primary, Secondary, and Their Functions

Here is the break up of types of Capital markets:

Primary Market

The primary market, also called the new issue market, deals with new securities issued for the first time to new investors. Its primary role is to help companies, governments, and institutions raise capital by selling these new securities to investors interested in supporting their growth or projects.

Secondary Market

The secondary market, also known as the stock market or share market, involves the buying and selling of existing securities like shares, debentures, bonds, and bills among parties. The secondary market deals with securities that are already in circulation. 

Primary Market Vs Secondary Market

Primary MarketSecondary Market
The Primary Market or New Issue Market (NIM) is where new shares are offered for the first timeThe Secondary or After Market involves the trading of previously issued securities
Shares can be purchased directly from the companyShares are purchased from another investor
It provides funds to new and existing companies for expansion and growthIt does not provide funding to companies, it focuses on trading existing securities
Here the securities can be sold only once, from the company to investorsSecurities can be bought and sold multiple times among investors
The company listed on the primary market receives funds from the sale of sharesInvestors gain or lose money based on the performance of securities
Securities are sold at a fixed price determined by the companyPrices fluctuate based on market demand and supply

Functions of Capital Market

  • Connecting Savers and Investors: The capital market links people who save money (savers) with those who need money to invest (investors). Savers provide funds to investors through the capital market
  • Supporting Industrialisation: The capital market helps establish industries by generating long-term funds, laying the foundation for industrial growth
  • Boosting Economic Growth: Easy access to funds encourages entrepreneurs to start or expand businesses, leading to economic growth and development
  • Creating Liquidity: Shares of public companies can be easily converted into cash by selling them in the stock market, providing liquidity when needed
  • Contributing to National Income: Funds flowing into the capital market are absorbed by various sectors, ultimately increasing the national income as they are used productively
  • Encouraging Saving and Investment: Savers are incentivised to invest their money through the capital market, leading to capital formation as funds are transferred to needy businesses
  • Promoting Productive Investments: The capital market redirects savings from less productive uses to productive investments, such as businesses, instead of luxury items like gold or jewellery
  • Ensuring Stability: A well-developed capital market with expert intermediaries helps stabilise the value of stocks and securities, minimising speculative activities
  • Fostering Economic Growth: Institutions within the capital market guide the flow of funds and allocate resources efficiently, encouraging growth in commerce and industry, both in the private and public sectors

How Does Capital Market Work?

The capital market acts as a platform that assists entrepreneurs in securing funds for projects while providing investors with opportunities to earn returns, all while managing varying levels of risk. The primary and secondary markets together comprise what we traditionally understand as capital markets. Here’s how the capital market works in its individual parts-

Role of Primary Markets

Primary markets allow entrepreneurs to make money by selling the general public shares of their business. Since all those smaller contributions add up, large projects can be funded even if people only make modest financial contributions. This aids business owners in overcoming their financial shortfall issues.

Role of Secondary Markets

In the secondary market, shares purchased in the primary market can be sold to other investors. The value of those shares may increase if the business succeeds, enabling investors to profit when they sell them. Investors can profit from their investments in this way.

Diversify Your Portfolio: A Look at Key Investment Vehicles

  • Apart from shares, there are other financial tools like debentures, mutual funds, and bonds that help raise money
  • Each of these tools has different levels of risk and potential returns, so investors can choose what best suits them.
  • For people who don’t have a lot of time or money to invest on their own, mutual funds are a great option.
  • Mutual funds collect money from many different people and invest it together in stocks and bonds. Professionals manage these investments to match people’s risk appetite.

Conclusion

The capital market serves as a crucial link between capital providers and users. It facilitates the mobilisation of savings and directs them towards productive enterprises. By providing a platform for investment, the capital market empowers individuals to grow their wealth.