Capital market

Topic: Financial Markets, Instruments, Insurance and Pensions · NCERT: Beyond NCERT

Meaning

The capital market is the market for long-term funds (money borrowed or invested for more than 1 year). In it, equity shares, bonds and other securities are first issued and then traded.

It matters because it moves household savings straight to firms and governments that need money for long-term investment such as factories, roads and new businesses. It does this without a bank loan in between. Its main formula links bond prices to interest rates:

Price of a perpetual bond = Coupon ÷ Market interest rate

Explanation

How it works: savers to long-term borrowers

• Savers (mostly households) have spare money. Borrowers (firms and governments) need money for many years.
• The capital market links them directly. This is called direct finance.

• A bank loan is indirect finance, because the bank stands in the middle.

• It does three other jobs:

• Price discovery. Buyers and sellers together set the price of a share or bond. That price shows what the market thinks the asset is worth today.
• Liquidity (how quickly you can turn an asset into cash). Investors can sell and exit quickly, so they are more willing to put money in for the long term.
• Risk-sharing. One company's risk is spread over lakhs of shareholders, so no single person carries all of it.

Its parts: instruments and stages

• By type of claim:
• Equity share = a unit of ownership in a company. It gives voting rights and a residual claim (the shareholder gets what is left after workers, lenders and taxes are paid). So shareholders gain most in good years and lose first in bad years.
• Bond (debenture) = a debt instrument. The issuer promises a fixed yearly interest (coupon) and returns the principal on a set date. A bondholder is a lender, not an owner.

• Hybrid instruments mix the two. A preference share gets its dividend and capital back before equity holders but usually has no voting rights. Convertibles are another example.

• By stage:

• Primary market. The company sells new securities, for example through an IPO (Initial Public Offering). The money goes to the company.
• Secondary market. Investors trade existing securities among themselves on a stock exchange. The company gets no new money.

• The link between them:

  • A busy secondary market means buyers know they can sell later.
  • So they are more willing to buy new issues.
  • So the primary market works better.

• By venue:

• Exchange-traded. Contracts are standard. A clearing corporation stands between buyer and seller, so each side is protected if the other fails to pay.

• OTC (over the counter). A private, custom deal between two parties. It carries counterparty risk (the risk that the other side does not pay).

• Derivatives (futures, options, swaps) are contracts whose value comes from an underlying asset such as a share. They are used to hedge (reduce risk) and also to speculate.

What makes prices rise or fall

• Interest rates move bond prices in the opposite direction.

• Market rates rise → old bonds pay less than new ones → fewer people want old bonds → their price falls.

• Worked example 1 (bond): a perpetual bond (a bond with no end date) pays a coupon of ₹100 a year.

• Market rate 10% → price = 100 ÷ 0.10 = ₹1,000

• Market rate 12.5% → price = 100 ÷ 0.125 = ₹800

• Worked example 2 (equity): a company has 1 crore shares and you hold 10,000.

• Your stake = 10,000 ÷ 1,00,00,000 = 0.1% of the company.

• You get 0.1% of any dividend (a share of profit paid out).

• Flow of savings. When households move money from gold and property into shares and funds, more money flows into the capital market.

In India

• Stock exchanges:
• BSE was set up in 1875 as the Native Share and Stock Brokers' Association. It is Asia's oldest stock exchange.
• BSE's index, the Sensex, tracks 30 large companies. Its base year is 1978-79 = 100. If the Sensex reads 80,000, these shares are worth about 800 times their base-year level.
• NSE was set up in 1992 and began screen-based trading in 1994. This brought all-India access, faster trades and more open pricing. Its main index is the Nifty 50.

• Paper share certificates and open-outcry trading (brokers shouting bids on the floor) gave way to computer screens. Shares are now held electronically in demat accounts.

• Regulator: SEBI (Securities and Exchange Board of India):

• It was set up in 1988 as a non-statutory body, so it had no legal power to punish.
• After weak supervision was exposed by the Harshad Mehta scam (1992), it got statutory powers in January 1992 through the SEBI Act, 1992 [2].
• Under the Act it has three duties: to protect investors, to develop the securities market, and to regulate it [2].

• It took over commodity derivatives when the Forward Markets Commission (FMC) merged with SEBI on 28 September 2015 [1][3].

• Other bodies:

• The RBI regulates G-secs (government securities), forex, and interest-rate and currency derivatives.
• The MCA handles company law under the Companies Act 2013.

• FSDC (Financial Stability and Development Council), chaired by the Finance Minister, coordinates all the regulators [5].

• Latest data (Economic Survey 2025-26):

• The share of equity and mutual funds in yearly household financial savings rose from 2% (FY12) to over 15.2% (FY25) [4].
• Individual investors held 18.8% of equity ownership in September 2025 [4].
• 235 lakh demat accounts were added in FY26 (till December 2025), taking the total beyond 21.6 crore [4].
• Unique investors crossed 12 crore in September 2025, and nearly one-fourth are women [4].

Don't confuse with

• Money market: it deals in short-term funds (up to 1 year), such as treasury bills, call money, commercial paper and certificates of deposit. The capital market deals in funds for over 1 year.
• Stock market: it is only the part of the capital market organised through exchanges like BSE and NSE. The capital market is wider. It also covers new issues, bonds and OTC deals.
• Primary vs secondary market: both are parts of the capital market. The company raises money only in the primary market. Trading on BSE or NSE is secondary-market activity.
• Bank credit (indirect finance): a bank takes deposits and lends them out. The capital market links savers and borrowers directly.

Prelims Hooks

• Capital market = over 1 year; money market = up to 1 year. T-bills and commercial paper are money-market instruments, not capital-market ones.
• A company gets new money only in the primary market, for example through an IPO. Trading of existing shares is secondary.
• SEBI was non-statutory from 1988 and became statutory under the SEBI Act 1992 [2]. It took over commodity derivatives from FMC on 28 September 2015 [1][3].
• Trap: G-secs, forex and interest-rate/currency derivatives are regulated by the RBI, not SEBI.
• BSE (1875) is Asia's oldest stock exchange, and the Sensex base is 1978-79 = 100. NSE (1992) started screen-based trading in 1994.
• Bond price and market interest rate move in opposite directions (perpetual bond price = coupon ÷ market rate).

Mains Points

• Financialisation of household savings (households shifting savings from gold and property into financial assets): gains vs risks.
• Gain: the equity and MF share of household financial savings rose from 2% (FY12) to over 15.2% (FY25), and demat accounts exceed 21.6 crore [4]. More long-term capital flows to firms, and India depends less on bank loans and foreign money. Savings kept in gold lie idle and add to imports.

• Risk: new retail investors, many from small towns, may take on risks they do not understand, especially in derivatives. Investor education and SEBI's safeguards must grow as fast as participation.

• Post-1991 capital-market reforms: SEBI got statutory powers (1992) [2], NSE began screen trading (1994), and demat holding and clearing corporations came in. Together they cut fraud and settlement risk and made markets more transparent. This is useful for GS-III answers on reforms and investment.

• Regulating a growing market: India's sectoral model (SEBI, RBI, IRDAI, PFRDA, coordinated by FSDC) brings deep expertise to each field. But it also allows turf disputes, such as the ULIP (Unit-Linked Insurance Plan) dispute of 2010, and regulatory arbitrage (firms designing a product to fall under the softest regulator). Merging FMC into SEBI (2015) shows a move to one set of rules where products are similar [1].

Related concepts

• Stock market
• Equity share
• Preference share
• International Financial Services Centre

Read more

• Financial markets: functions, structure and the regulatory map