Functions of Capital Market (Primary Market and Secondary Market)

Functions of Capital Market

Primary Market and Secondary Market

Meaning of Capital Market

Capital Market is generally understood as the market for long-term funds. This market supplies funds for financing the fixed capital requirement of trade and commerce as well as the long-term requirements of the Government. The long-term funds are made available through various instruments such as debentures, preference shares, and common shares. The capital market can be local, regional, national, or international. The capital market is classified into two categories, namely,

– Primary market or new issue market, and

– Secondary market or stock exchange.

Primary Market (New Issue Market)

A primary market refers to any market where new shares of stock are sold. The primary market is the entry market for companies and investors, where a company or institution that requires initial or additional capital sells its shares or financial instrument to the investors. For example, Initial Public Offering (IPO), public offer, rights issue and bond issue are done on the primary market. The primary market is also unique that the initial buyer is the only person who can exchange the securities for funds. When companies are willing to go for publicly listed on the stock exchange and wants to collect funds from general investors, they first sell their financial instrument in the primary market. Primary market is the first place for trading financial instruments including stocks and bonds.

Functions of Primary Market

The main function of a primary market can be divided into three service functions. They are: origination, underwriting and distribution.

1. Origination: Origination refers to the work of investigation, analysis and processing of new project proposals. Origination begins before an issue is actually floated in the market. The function of origination is done by merchant bankers who may be commercial banks, all India financial institutions or private firms.

2. Underwriting: When a company issues shares to the public it is not sure that the whole shares will be subscribed by the public. Therefore, in order to ensure the full subscription of shares (or at least 90%) the company may underwrite its shares or debentures. The act of ensuring the sale of shares or debentures of a company even before offering to the public is called underwriting. It is a contract between a company and an underwriter (individual or firm of individuals) by which he agrees to undertake that part of shares or debentures which has not been subscribed by the public. The firms or persons who are engaged in underwriting are called underwriters.

3. Distribution: This is the function of sale of securities to ultimate investors. This service is performed by brokers and agents. They maintain a direct and regular contact with the ultimate investors.

Secondary market or stock exchange

Stock exchange is a specific place, where trading of the securities, is arranged in an organized method. In simple words, it is a place where shares, debentures and bonds (securities) are purchased and sold. The term securities include equity shares, preference shares, debentures, government bonds, etc. including mutual funds.

Role/Functions of stock exchange in capital market

Presence and vibrant functioning of a stock exchange is necessary for a developing economy. It reflects healthy financial and investment conducive atmosphere in the economy. The Indian securities market is considered as one of the most promising emerging markets. It is one of the top eight markets of the world. The stock exchange plays a vital role in the process of raising resources for the development of corporate sector. In the absence of the stock exchange it would be impossible for private enterprises, industries and entrepreneurs to survive and grow. A stock exchange plays a significant role in a capital market which are mentioned below:

1. Encourages capital formation: A common investor is attracted to capital market. Today investor prefers to divert his surplus and savings in the securities like shares, debentures, mutual funds etc. As a result new capital formation is speeded up.

2. Resource Mobilsation: Due to continuous buying and selling of the securities the resources of the economy flow from one company to other company giving comparatively higher returns. This helps mobilisation of resources.

3. Help in repaid economic development: The stock exchanges help in the process of rapid economic development by speeding up the process of capital formation and resource mobilization. It helps in raising the medium and long term capital for the development and expansion of the companies. New industries and commercial enterprises easily get capital funds through a stock exchange.

4. Flexibility in investments: The stock exchanges provide liquidity to the investment made in the securities. As there are multiple options, investors can flexibly go on switching their investment where it is more beneficial?

5. Value addition to the securities: Listing of shares on a stock exchange adds to the prestige and reputation to companies. With the advantage of listed shares it can raise loans from corporate sector.

6. Protects investor’s interest: All the transactions in the stock exchanges are effected and controlled by the Securities Control (Regulation) Act 1956. The stock exchanges protect the interests of the investors through the strict enforcement of their rules and regulations. The malpractices of the brokers are punishable with heavy fine, suspension of their membership and even imprisonment.

7. Motivation to Management: A stock exchange allows the trading of listed securities only. Listing procedure requires to comply with certain guidelines for protecting the interests of investors and obviously are under strict supervision of stock exchange. If companies do not comply with the rules and regulations of the exchange, the shares of a company can be delisted. To avoid such unfavorable and undesirable consequences every company manages its affairs more cautiously and effectively.