CAPITAL MARKET – CONCEPTUAL FRAMEWORK:

The relationship between finance capital and industry dates back to the origin of
modern industrialization and has been shaped by the way investment patterns and
financial systems evolved. The nature of the latter two, in turn, is influenced by the socio-
economic and political attributes prevalent in a country. While each economy does have
its own ‘unique financial system’, two broad systems of industrial financing are identified
in the literature namely, credit-based systems and capital market-based systems. Across
the world, there was a transformation in financial intermediation from the eighties
onwards. This movement, even if marginal in some of the developing countries, was
away from a credit-based financial system to a capital market-based system, and was
partly due to a shift in policies from ‘financial repression’ (credit controls and other
modes of priority sector promotion) to ‘financial liberalisation’. This led to an increasing
significance of capital markets in the allocation of financial resources.

Sound and vibrant Capital Market is a prerequisite of sustainable economic

development of a country. The term "Capital Market" refers to the facilities and
Institutional arrangements for the borrowing and lending of long-term funds. It consist
series of channels through which the saving of community are made available for
industrial and commercial enterprises and for public. The capital market implies a
number of individuals and institutions (including Govt.) that chanalise the supply and
demand for long-term capital and claims on capital. The stock exchanges, commercial
banks, insurance companies, co-operative banks, saving banks, development banks,
investment companies or trust etc. are important constituents of the capital market. The
capital market has three important components namely the suppliers of loanable funds,
the borrowers and the intermediaries who deal with the lenders on one hand and the
borrowers on the other hand. It embraces not only the system by which the public take up
long-term securities directly or through intermediaries but also elaborate network or
institutions responsible for short-term and medium term lending.
 The attainment of planned economic development needs a well regulated,
organised, efficient and effective capital market for the saving from the households,
commercial undertakings etc. and chanalising the funds in the proper direction as laid in
the national objective. A sound Capital market implies the essential attributes of liquidity,
marketability, safety and price continuity to the long-term securities. In the words of
Livingston “It is the business of the capital market to facilitate the movement of the
stream of command over capital to the points of highest yield. By so doing it enables
control over resources to pass into the hands of those who can employ them most
effectively, thereby increasing productive capacity and swelling the National Dividend”1.

The securities market has essentially three categories of participants, viz., the
issuer of securities, the investors in the securities and the intermediaries. The issuers are
the borrowers or deficit savers, who issue securities to raise funds. The investors, who are
surplus savers, deploy their savings by subscribing to these securities. The intermediaries'
are the agents who match the needs of users and suppliers of funds for a commission.
These intermediaries perform functions to help both the issuers and investors to achieve
their respective goals. There are large variety and number of intermediaries providing
various services in the Indian securities market (Table 1.1). This process of mobilizations
of resources is carried out under the supervision and overview of the regulators. The
regulators develop fair market practices and regulate the conduct of issuers of securities
and the intermediaries. They are also in charge of protecting the interests of the investors.
The regulator ensures a high service standard from the intermediaries and supply of
quality securities and non-manipulated demand for them in the market.

Table 1-1: Market Participants in Securities Market

S.No. Name 2005 2006

1
Livingston. P – The English Capital Market, Mathien & Company, London 1934.
 1. Securities Appellate Tribunal 1 1

2. Regulators* 4 4

3. Depositories 2 2

4. Stock Exchanges

5. With Equities Trading 23 23

6. With Debt Market Segment 1 1

7. With Derivative Trading 2 2

8. Brokers 9,128 9,339

9. Corporate Brokers 3,733 3,933

10. Sub-brokers 13,684 23,479

11. FIIs 685 882

12. Portfolio Managers 84 132

13. Custodians 11 11

14. Share Transfer Agents 83 83

15. Primary Dealers 17 17

16. Merchant Bankers 128 130

17. Bankers to an Issue 59 60

18. Debenture Trustees 35 32

19. Underwriters 59 57

20. Venture Capital Funds 50 80

21. Foreign Venture Capital Investors 14 39

22. Mutual Funds 39 38

23. Collective Investment Schemes -- --

Source: ISMR 2006: a NSE publication

Capital Market Structure, Functions & Framework: The Corporate Sector draws
its capital needs from the following sources:
 1. Promoters Contribution,

2. Equity & Preference Capital raised from the shareholders (generally referred to
as equity capital),

3. Bonds/Debentures raised from the Public (generally referred to as Debt

Capital),

4. Term Loans from Banks & Financial Institutions,

5. Short-term Working Capital from Banks,

6. Unsecured Loans & Deposits, and

7. Internal generation of Funds (Profits/surpluses re-ploughed).

Of the sources enumerated above, item No.1 and 2 are held permanently and form the
risk capital. These are not repayable. Item No.3 is raised from the market for duration of
10 to 15 years or more, but this has to be eventually repaid. We call the source as
Corporate Debt Market, and funds raised as II Tier Capital. The debt market consists of
such corporate debt and also public debt (government securities & Treasury Bills)
Managed by the RBI. The others sources at item 4 to 6 are supplementary or stand-by
sources and these are all to be repaid as per contracted terms. Item No.4 is negotiated &
raised for 3 to 7 years from Banks/FIs, but normally not exceeding 10 years. Short-term
working capital Loan is generally a revolving facility and held over the years subject to
satisfactory dealings and abiding by the terms & conditions stipulated by the lending
Institution. Unsecured Loans & Deposits are at best supplementary sources, but these are
not very dependable. Internal generation of funds (profits & surpluses are used to
eventually redeem the debt borrowings mentioned at item No.3 to 6.

The basic capital edifice of a corporate body is built from item 1 to 3 above. With the
strength of this edifice it is possible to raise the remaining sources at item No.4 to 6. This
introduces us to the Capital Market (covering equity and corporate debt capital).
Promoters equity constitutes a comparatively a smaller portion, and hence the primary
source of capital for a large Corporate Institutions is from the Capital Market (providing
the equity capital & debt capital to business, trade & industry)

Composition of Equity/Corporate Debt Market

This is the market consisting of large number of individual investors, household

savers, professionals, agriculturists, who are able to retain a part of their current earnings.
They form the class of capital providers. On the other side the corporate bodies engaged
in Industry, trade and other business ventures are the productive users of significant
amount of capital. It is the Capital market that transforms the savings of large number of
individuals to productive channel to meet the demands of capital for Industry, trade and
business.

The individual savers are not organised. They can invest if they could secure the
trust and confidence that the funds invested would be prudently employed and they could
normally expect to get a fair return/reward on their hard-earned savings. This is the
function of organised capital market to regulate market forces to ensure fair dealings, to
motivate savings on the part of the investors and to secure smooth flow of savings/capital
from investors to capital seekers for productive needs.

Stock market is also referred to as the Corporate Debt or Capital Market. While
the money market, which deals with short-term financial needs of business and industry,
is restricted to funds needed for a period of one year or less, instruments of the
debt/capital markets are raised for medium or long term needs. Indian Stock Market
consists of three distinct segments:

1. The Public Debt Market i.e. the market for Government securities (also called Gilt-
edged Market). These are interest bearing and dated securities. This market is
regulated by RBI, the Central Bank of the country and banker to the Government.

2. PSU Bonds Market i.e. Bonds floated by public Sector units, nationalised banks and
financial Institutions for raising Tier-II capital and also debentures floated by
corporates. This is represented as the Corporate Debt Market.
3. The Equity Market for rising of equity or preference share capital by all corporates.
Money invested in company shares is not refundable, but if the shares are listed in a
stock exchange these can be sold or purchased, thus providing liquidity to such
investments. Shares do not carry interest, but shareholders can participate in sharing
the profits of the corporate body declared by way of dividends, bonus shares etc.
While the hope of receiving attractive dividends motivates the public to subscribe to
the share capital, declaring dividend is not a legal obligation on the part of the
companies, and hence not a right on the part of the shareholders. But shareholders
enjoy various other rights as conferred by the Indian Companies Act, 1956. Indian
Public companies generally follow the objective of increasing shareholders wealth as
the prime goal of financial management. Here it is relevant to mention about two
categories of stock market, i.e.

1. Primary market covering new public issues of all categories of securities,

including G-sec, bonds and equity/preference capital.

2. Secondary market, which deals with already issued securities of all types.
Transactions of the secondary market are carried out through one of the
authorised stock exchanges, where the traded security is listed.

The Primary Stock Market

It is also called the market for public issues. This market refers to the raising of
new capital (equity or debt i.e. equity shares, preference shares, debentures or Rights
Issues) by corporate. Newly floated companies or existing companies may tap the equity
market by offering public issues. When equity shares are exclusively offered to the
existing shareholders, it is called "Rights Issue". When a Company after incorporation
initially approaches the public for the first time for subscription of its public issue it is
called Initial Public Officer (IPO). Successful floating of a new issue requires careful
planning, timing of the issue and comprehensive marketing efforts. The services of
specialised institutions, like underwriters, merchant bankers and registrars to the issue are
available for the corporate body to handle this specialised job. Underwriters are financial
institutions, which undertake to secure a committed quantum of equity/debt subscribed by
the public, failing which they accept these shares/bonds as their own investment. It is
referred to as the issue or that part of getting devolved on the underwriters. The
transactions relating to the primary market i.e. public/rights issues are not carried out
through stock exchanges. However there is effective regulation of SEBI at every stage of
a public issue. This is done through merchant bankers, underwriters and registrars to the
issue each acting at different points. Subscriptions to the new issue are collected at
specific branches of one or more collecting banks within a prescribed span of time,
represented by the dates of opening of the issue and closing of the issue.

Secondary Stock Market

The Secondary Market deals with the sale/purchase of already issued equity/debts
by the corporates and others. The sale/purchase of these securities are carried out at the
specific Stock Exchange(s), where the companies get their public issues listed for trading.
The main function of the secondary market is to provide liquidity to the listed securities
by enabling a holder to easily convert the securities into cash through the stock
exchanges. An individual or an Institution can either hold a portfolio of securities as a
permanent investment, or he can hold a basket of securities for short-periods and engage
in buying and selling them to gain from market fluctuations. The secondary market also
acts as an important indicator of the investment climate in the economy. When prices of
existing securities are rising and there is large trading in the existing shares, such a boom
in the secondary market correspondingly signifies that new issues if floated at that point
of time would be successfully subscribed.

Functions of the Capital Market

1. The organised and regulated capital market motivates individual to save and invest
funds. The availability of safe and profitable source of investment is an essential
criterion to create propensity to save and invest on the part of the earning public.
 2. It provides for the investors safe and productive channels for investment of
savings and secures the recurring benefit of return thereon, as long as the savings
are retained.

3. It provides liquidity to the savings of the investors, by developing a secondary

capital market, and thus makes even short term savings, consistently available for
long-term users

4. It thus mobilises savings of large number of individuals, families and associations

and make the same available for meeting the large capital needs of organised
industry, trade and business and for progress and development of the country as a
whole and its economy.

To discharge these functions, the organised capital market accepts a dual

responsibility to develop the market and to promote savings & Investment; and to
regulate the players in the market vis-a-vis the investor and to enforce market discipline,
through market regulators and registered intermediaries. Such that the unorganised small
man is able to deal through these regulatory bodies and the intermediaries, and need not
necessarily has to come into direct contact with the ultimate seekers of his savings.

Regulatory Body: SEBI (the Securities & Exchange Board of India) an autonomous and
statutory body acts as the market regulator and market developer. It regulates and
controls the capital users and all functionaries between the users and the investors.

The Stock Exchanges: There are 23 Stock Exchanges registered with SEBI and under its
regulation. They provide a transparent and safe (risk-free) forum of a market for investors
to transact and invest their funds.

The Depositories: The depositories are innovative institutions, who are able to render the
market paperless by holdings securities electronically, providing ease and speed for those
transacting in the market.

The Registered Intermediaries: They consist of brokers, sub-brokers, Trading and

Clearing Members, portfolio managers, Bankers to Issue, merchant bankers, registrars,
underwriters and credit rating agencies. They all provide a basket of services to the
investors to lesson risk and make transacting earlier and smooth. They are all registered
with SEBI and act under the regulation of SEBI abiding by the Code of Conduct
prescribed for each of them governing their respective roles.

The emergence of capital market can be traced back to the second half of the
eighteenth century when the transactions were limited to loan stock transactions of the
East India Company; by 1830 some corporate stocks had emerged due to economic boom
and establishment of textile mills. Stock exchanges at Mumbai, Ahamdabad and Kolkata
started functioning though without formal organisation. Mumbai stock exchange was
formalised in 1875 with the establishment of Native Share and Share Broker Association.
Stock exchange trading got a big boost during the First World War and Second World
War with the incorporation of large number of joint stock companies and coming up of
new stock exchanges at Chennai, Delhi, Nagpur, Kanpur, Hyderabad and Bangalore. The
Amsterdam Bourse seems to be the world's oldest capital market where stock business
has its start as early as 1585. The London capital Market becomes the world's second
oldest capital market which was established in 1773.