The Indian capital market is one of the fastest growing in the world. It refers to the various financial markets and exchanges in the country where securities such as stocks, bonds, and derivatives are traded. Here we understand the structure of capital markets and the instruments traded herein.
What are capital markets?
Capital markets refer to the financial markets where securities, such as stocks and bonds, are bought and sold. These markets provide a means for companies, governments, and other entities to raise capital by issuing securities and for investors to buy and sell these securities. The two main types of capital markets are the primary market, where new securities are issued, and the secondary market, where existing securities are traded. The most well-known capital market is the stock market, but there are also bond markets, commodity markets, and other financial markets that make up the capital markets.
Functions of capital markets
Capital markets facilitate the flow of capital from investors to companies and governments that need funding. They include the stock market and bond market and provide a mechanism for companies to raise money by issuing stocks and bonds and for investors to buy and sell those securities. They also help to transfer risk by allowing investors to diversify their portfolios and provide liquidity for buying and selling securities. Additionally, capital markets help to allocate resources efficiently by directing funds to companies and projects with the best growth prospects.
Instruments traded in the Indian capital markets:
Equities:
Equity is a capital market instrument that businesses issue to raise money. It also goes by the name equity share. You can acquire ownership and voting rights in a firm by purchasing its shares. Until you sell the shares on the secondary market or the business is liquidated, you retain a portion of the company. Additionally, you get share in the company's gains and losses, and dividends are given out for the earnings. The performance of the company, which affects the investor's return, determines how much the share value will rise.
Equity has historically produced larger returns than other capital market assets while it is a high-risk investment.
Preference shares:
These shares have a preference over equity shares (holders). They are those that receive first consideration when dividends or liquidation proceeds are paid out. According to this rule, preference shareholders must get dividends or other payments before equity stockholders. Preference shareholders do not have voting privileges within the firm, nevertheless. Unlike equity shares, preference shares are often not traded on the secondary market. The various types of preference shares are:
Redeemable: The issuing company has the option to subsequently choose repurchase to redeem the preference shares
Irredeemable: The redemption happens only upon liquidation of the company
Convertible: Preference shares may be converted to equity shares at a later date
Mutual Funds:
Mutual fund remains the most popular means to invest in capital markets. While mutual fund are not directly traded in the markets on a real-time basis, the funds invest directly into instruments that are traded on capital markets. There are various types of mutual fund with varied risk / return profile. Here are the most basic types of mutual fund:
Equity mutual funds: Invests atleast 65% in equity stocks traded in the stock market.
Debt mutual fund: Invests in debt instruments including bonds, T-bills, commercial paper etc.,
Balanced mutual funds: These funds invest in both equity and debt mutual fund, this is ideal for someone with moderate risk profile and safe, modest returns.
Debt instruments:
To finance capital-intensive projects, both governments and businesses issue debt instruments. Debt is a kind of borrowing with no ownership rights in the organisation that is issued on primary or secondary markets. The term of the debt instruments is typically short, after which the issuing corporation is required to refund the principal.
Monthly, quarterly, semi-annually, or yearly, interest payments are made. Municipal, governmental, and corporate bonds and debentures are examples of debt instruments. Debt investments are less risky as compared to equity investments. However, the default risk might be greater if the issuing company's financial situation is poor. Therefore, you must invest in debt instruments after examining the issuing company's credit rating and financial situation.
Derivatives:
Capital market tools known as derivatives derive their value from an underlying asset. Bonds, equities, metals, commodities, money, and so on are all examples of underlying assets. These instruments are traded mostly for speculative purposes, although they may also be used for arbitrage and hedging. Derivatives are, therefore, ideal for seasoned investors in the financial market as they are seen as being more volatile and risky than stocks. Futures and options contracts are traded in secondary markets in India.
Exchange-traded funds:
Using ETFs, a lot of individuals may pool their money to invest in bonds, stocks, or gold on the capital market. Most ETFs are registered with the Securities and Exchange Board of India (SEBI) and have characteristics of both shares and mutual funds. ETFs are similar to mutual funds and are beneficial to investors who wish to invest in an index, a basket of equities, or a commodity.
Conclusion:
The above instruments are the most prominent ones traded on the capital market. It is important to understand the nuances of these instruments before investing in them. For assistance, you can always reach out to the experts at the Tata Capital Wealth team for further information.
14 February 2023
5 mins read
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