Guide to Capital Markets

It is vital for the economy that funds flow from individuals and financial intermediaries to the industry, commerce, and the government to help them in capital formation. When these funds are put to productive usage, it generates profits and helps in increasing the national income of a country. Capital Markets facilitate this channelization of funds from suppliers of capital to the ones in need of capital.

Capital markets operate through the stock exchange and facilitate capital transfer from investors(supplier of funds) to businesses and industries(users of funds) that need finance for different projects or investments. It is focused on mobilizing funds for long-term investment.The supplier of funds is individuals and financial institutions such as companies that offer life insurance, pension funds, charitable foundations, etc., whereas the users of funds maybe industries, government, home or vehicle buyers, etc. Capital markets primarily deal in two categories of securities – Equity and Debt securities. Both the securities contribute to capital formation and come with varying risks and returns for the investors.

There are mainly two types of capital markets – Primary and Secondary market.

• Primary Market: Primary markets are for investors who are interested in buying securities directly from the issuing companies in the form of Initial Public Offerings (IPO). Different entities, such as governments, companies, and public-sector organizations, raise funds by selling new stocks or bonds through IPOs. Initial public offers are made when a company issues stocks for the first time to the public.
• Secondary Markets: A secondary market deals with the trading of secondary or previously-issued securities and issuing. Here, the existing financial instruments, such as shares and stocks, are sold and purchased between investors. The secondary market is regulated by the Security and Exchange Commission (SEC), and the issuing companies are not a part of it.

Stock exchanges such as the Bombay Stock Exchange (BSE), National Stock Exchange (NSE) and the New York Stock Exchange (NYSE), and other major exchanges across the globe are some of the examples of secondary markets.

Companies and corporations often need to raise funds to venture into new businesses, or expand their existing business to new markets, invest in research and development, debt payoff, etc. These funds are raised from the internal company's profit, but external funding may require additional capital.Below are some of the ways to raise funds from external sources and investors:

• IPO(Initial Public Offer): IPOs are either fresh securities or existing securities offered to the public by an unlisted company for the first time. Making IPOs allows companies to list themselves and make their securities available for trade on the stock exchange.
• E-IPO(Electronic – Initial Public Offer): It allows investors to purchase shares through the internet. In agreement with the stock exchange, the company offers its shares to the public in online mode for a speedy and convenient process. The online applications from the public are submitted to the broker for further processing.
• FPO(Further Public Offer): FPOs are offered by companies that are already listed on a particular stock exchange. When listed companies offer the further issue of securities for the public, it is referred to as FPOs. It is also known as a secondary offering.

• Preferential Allotment: When a listed company offers its securities to a selected group of investors as per the SEBI guidelines, it is referred to as preferential allotment. The issuing company must comply with all the provisions related to pricing, disclosures in the notice, lock-in, etc., and requirements specified in the companies act.
• Qualified Institutions Placement(QIP): When a listed company offers its securities to only qualified institutional buyers as per the SEBI guidelines, it is referred to as QIP.

1. Public Issue: It is one of the best ways for a company to raise funds. When companies offer securities to new investors for including them as a shareholder in the company, it is referred to as a public issue. Public issues can be offered as IPOs(Initial Public Offer) , E-IPOs(Electronic IPOs), or FPOs(Further Public Offer).
2. Rights Issue: When a company needs additional funds and offers issues to its existing shareholders before offering to the general public, it is called the rights issue. It gives the existing investors the first chance to invest further in the company. The right shares are allotted on a pro-rata basis. If the existing shareholders do not want to make additional investments, the shares are then offered to the public.
3. Private Placement: Due to the huge cost associated with IPOs or other reasons, some companies may prefer to offer their securities to a smaller and selected group of investors. These investors may be insurance companies, banks, mutual funds or pension funds, etc. It is different from a public issue where securities are available to all types of investors in the open market. Private placements can be of two types as below:

Below are some of the important functions of capital markets:

• Promotes Economic Growth: Capital market plays a key role in promoting economic growth by acting as a link for the flow of funds from people having surplus capital to the people who need capital. The accumulated capital is used in the betterment and expansion of trade and industry in both private and public sectors, leading to improved economic growth and national income of the country.
• Stabilized Security Pricing: Apart from mobilizing funds, capital markets also help in stabilizing stock prices by providing capital to the borrowers at lower interest rates.
• Promotes Savings: After the emergence of capital markets, the banks and tax authorities have started providing facilities and benefits to their customers leading to the promotion of saving habits among people. Also, it discourages people from unnecessary spending on unproductive assets like land, gold, etc.
• Minimization of Transaction Cost: The capital market allows trading of long-term securities, thereby reducing the overall cost involved in the complete trading process. Nowadays, most of the trading is done in online mode, and hence the process is quick and convenient.
• Provides Investment Avenues: Capital markets deal in the trading of long-term securities and hence acts as an opportunity for investors who wish to invest their surplus money for a longer time. Looking at the good interest rates offered by the capital markets, people are encouraged to invest their savings in return for some extra income.

Capital markets play an important role in channelizing funds for ventures and projects that promote overall economic growth. Also, it motivates individuals to save and invest in equities and bonds on offer. It is also an opportunity for them to earn profits in the form of interest and dividends earned on various securities.

The information contained herein is generic in nature and is meant for educational purposes only. Nothing here is to be construed as an investment or financial or taxation advice nor to be considered as an invitation or solicitation or advertisement for any financial product. Readers are advised to exercise discretion and should seek independent professional advice prior to making any investment decision in relation to any financial product. Aditya Birla Capital Group is not liable for any decision arising out of the use of this information.