Q. Consider the following markets:

1. Government Bond Market
2. Call Money Market
3. Treasury Bill Market
4. Stock Market

How many of the above are included in capital markets?

• Only one
• Only two
• Only three
• All four

Answer: (b) Only two

Capital Markets

• A capital market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold, in contrast to a money market where short-term debt is bought and sold.
  • Capital markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments.
• The players in the capital market industry deal in capital market instruments like shares, bonds, ETFs, debentures, derivatives like futures, options, and swaps.
• The capital market intermediaries are stock exchanges like BSE, NSE, MCX (Commodity Exchange), banks, brokers, insurance companies, and other financial institutions.
  • It is through these intermediaries that capital markets mobilise savings to investments.
• Capital markets are mainly divided into 2 different types.
  • Primary Markets: The primary market is the part of the capital market that deals with the issuance and sale of securities to investors directly by the issuer. An investor buys securities that were never traded before. Primary markets create long term instruments through which corporate entities raise funds from the capital market.
  • Secondary Markets: The secondary market, also called the aftermarket and follow on public offering is the financial market in which previously issued financial instruments such as stock and bonds are bought and sold.
• Examples of capital markets:
  • Stock Market: A stock market, equity market or share market is the aggregation of buyers and sellers of stocks, which represent ownership claims on businesses
  • Bond Market: The bond market is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt securities
  • Currency and Foreign Exchange Markets: The foreign exchange market is a global decentralized or over-the-counter market for the trading of currencies. This market determines foreign exchange rates for every currency.
• Capital Market Instruments:
  • Bonds: Bonds are debt securities that trade on the stock exchange. Companies and firms issue bonds to raise money for the growth and expansion of the company. Bonds are debt instruments, hence bondholders receive interest. At the end of the maturity period, the company pays back the principal amount along with interest.
  • Stocks: Stocks represent ownership of a company. Each share is a part of the ownership of the company. Shares trade on the stock exchange, and the share price depends on market demand and supply. The person holding shares of a company is the shareholder. Shareholders receive dividends. Also, in the case of equity shares, they have voting powers and can vote for important decisions in the annual general meeting of the company. During liquidation, they get a share of the assets after the liabilities are paid off.

Money Market

• A market for securities that have a maturity of less than one year is a money market. The securities in the money market are short term in nature, highly liquid.
• A few of the money market instruments are treasury bills, repos, certificates of deposits, and banker’s acceptances.
• The primary function of the money market is to cater to the immediate cash needs of the economy. This is usually done by adjusting the cash positions of different players in the market. In other words, the money market caters to the liquidity needs of the economy.
• The interest rates of money market instruments serve as a benchmark for all other debt securities. Moreover, RBI and the government use money market interest rates to frame future monetary policy.
• The major players in the money market are RBI, banks, Non-Banking Financial Companies (NBFCs), and acceptance houses. Moreover, All India Financial Institutions and Mutual Fund houses can access call and notice money.
  • Individuals, companies, firms and other institutions can invest in treasury bills and other money market instruments.
• Types of Money Market Instruments:
  • Treasury Bills (T-Bills)
    • The Reserve Bank of India issues the Treasury Bills (T-Bills) on behalf of the central government to raise funds.
    • T-bills are short term financial instruments with a maximum maturity period of one year. There are 14 days, 91 days and 364 days T-bills.
    • They are issued at a discount and repaid at par on maturity.
  • Bills of Exchange or Commercial Bills
    • Businesses issue bills of exchange to meet their short term money requirements. The creditor can discount their bill of exchange with a broker or a bank. They are highly liquid instruments as they are transferable from one person to the other.
  • Commercial Papers (CP)
    • Large businesses and corporations issue Commercial Papers (CPs) to raise capital to meet their short-term business requirements. These corporations have high credit ratings, which acts as a security to the unsecured commercial papers.
    • CPs have a fixed maturity that ranges from 7 days to 270 days. Furthermore, investors can trade CPs in the secondary market.
  • Certificate of Deposits (CD)
    • Corporates, scheduled commercial banks, trusts, individuals issue Certificate of Deposits (CDs) that are negotiable term deposits. Commercial banks accept them and they work similarly to a promissory note.
    • The duration of a CD varies from 3 months to one year. While CDs issued by financial institutions have a longer duration that varies between one year to three years.
  • Repurchase Agreements
    • Repurchase Agreements, also known as repos, is a legal agreement between two parties. One party sells a security to another with the promise of purchasing it back from the buyer at a later date. The seller buys back the security at a prefixed date and amount.
    • The interest rate that the buyer charges is the repo rate. Repos are a quick way to raise short term capital requirements that also earn good returns for the buyer.
  • Banker’s Acceptance
    • Banker’s Acceptance is a financial instrument that an individual or a business creates in the name of a bank. The issuer has to pay the instrument bearer a specific sum on a specific date. It is usually anywhere between 30 and 180 days after the issue. As a commercial bank guarantees the payment, it is a safe financial instrument.
  • Call and Notice Money
    • In a Call Money scenario, the funds are borrowed for a period of one day. On the other hand, in a Notice Money market, the funds are lent up to a duration of 14 days.
      • Both the options do not have any collateral security.
    • Cooperative banks and commercial banks borrow and lend funds in call and notice money markets. Mutual funds and financial institutions are only lenders of funds.