Capital market consists of development banks, commercial banks, stock exchange etc. It can be further classified into primary market and secondary market.
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A company issues shares and/or debentures to establish new business or to expand it, the market where this company gets listed for the first time to issue new securities is called primary market. Since only new securities are only traded, it is also known as "new issue market". The investors in this market consists of bank, financial institution, insurance companies, mutual funds and individuals.
A company may use following methods to issue securities in the primary market:
1. Initial Public Offering (IPO):
A company may issue its securities to the public for first time through various methods such as through prospectus, offer for sale or through private placement.
a. Through Prospectus: In this method, companies provide prospectus which give details of the company and then invites public to apply for the securities offered. Companies reach out to public through advertisements in newspaper or magazines.
b. Offer for Sale: In this companies don't directly sell their securities to public but sell it to the intermediary, known as Issue House. These intermediaries sell these securities to the public at higher price. This method provides a swift way to raise capital for the company.
c. Private Placement: In this companies sell their securities to a selected few wealthy individuals or institutional investors.
2. Right Issues:
Under this method, new shares are made available to its existing shareholder commensurate with the existing shares. The shareholder may buy these new shares or assign a part or all of these shares to another person. These new shares are generally offered at a price below the market price.
Secondary market is often termed as stock market or stock exchange. It is a place where existing securities such as shares, debenture or bonds are sold and purchased regularly. It is the secondary market which determines the price of a stock as most of the securities are traded here.
Functions of Secondary Market:
1. It facilitates purchasing and selling of already listed securities regularly and conveniently. It gives investors an opportunity to buy and sell these securities as and when they want, this leads to high degree of liquidity.
2. Determines the price of the securities based on fundamental law of demand and supply.
3.Maintains and provides regular information on the the prices and sales volume to press and other media. This helps investors make an informed decisions on purchase and sell of interested securities.
4.Stock exchange transactions are conducted among its members only with adequate transparency and established legal framework, thus providing high degree of security from fraudulent practices.
5.As stock market channelize savings into most productive investment avenues. This leads to economic growth in a country.
Now let me give an example for better understanding of all these procedures. Suppose an entrepreneur needs to expand his business, he needs capital to buy assets like machinery, factories, trademark, patent, technical expertise as well as to run day-to-day operations. So he can sell its securities by getting listed with at least one stock market. Once he sell its financial securities to the investors either in the form of stocks or bond, it raises the required capital. Now these financial securities can in turn be sold on secondary market. Assume that the company is doing well and there is an anticipation of upward movement in the stock price. More people will now like to buy its stock and a few willing to sell. This leads to high demand and low supply scenario. To buy these stocks buyer need to bid a higher price to match the asked price of the seller. This increases the stock price of the company. On the contrary, if the company is not doing well. More people will like to sell its stock and a few will be willing to buy. This leads to high supply and low demand scenario. This decreases the price of its stock.