The Basics of Capital Market: Meaning, How it Works, and Types

September 14, 2021 Trading 5 min read

Have you ever thought about investing in stocks or bonds to grow your savings? If so, you must have heard about capital markets. Capital markets are financial markets where individuals and businesses trade various financial securities, such as stocks, bonds, and derivatives. Capital markets are mainly used for the purpose of securing funding, typically for a company, to be used in operations or for expansion. 

In this article, we will cover what capital markets are, how they work, and their types, elements, and functions.

What Are Capital Markets?

Capital markets are financial markets where people and businesses trade financial securities like stocks and bonds. These markets allow businesses to raise funds and provide investment opportunities. Businesses and governments use the capital market to create cash inflows and resources to be used for revenue generation and expansion. Capital market instruments include equity shares, preference shares, bonds, debentures, derivatives, and hybrid tools, among others.  

The equity market and debt market are both subcategories of the capital market, which together comprise the lending and borrowing of all capital investments. 

How Does a Capital Market Work?

A capital market provides companies with an avenue to raise funds for their business operations. It involves a 3-fold process: 

Issuance: Companies offer stocks or bonds to investors in exchange for money.
Investment: Investors purchase these financial instruments, aiming to grow their wealth over time.
Transaction: Upon receiving the money, the investor gets a share or a bond, and the company receives the funds it needs.

When an investor wants to liquidate their assets, they can sell them in the capital market. The capital market, being a network of buyers and sellers, allows investors to find buyers for their securities. This process allows the investor to liquidate their investment, often at a profit. 

Regulatory bodies oversee the capital market to ensure its proper functioning. In India, the main regulatory authorities are:
– The Securities and Exchange Board of India (SEBI)
– The Reserve Bank of India (RBI)

Each regulatory authority has distinct roles and jurisdiction areas to manage different aspects of the capital market effectively.

Types of Capital Markets

Let’s look at the types of capital markets in India. They can be divided into primary and secondary markets based on the mode and choice of investment assets.

Primary Market
This market is for new securities that are issued to the public for the first time, known as Initial Public Offerings (IPOs). An intermediary, such as an investment bank, helps a company determine the right price for their launch. After receiving approval from the SEBI, the IPO is launched. The company raises funds from investors who subscribe to the issue. Investors receive shares based on the subscription volume and price. Once listed, these shares can be bought and sold on the market. 

Secondary Market
After the initial issue, all securities are traded on the secondary market. In India, there are 2 main stock exchanges: the National Stock Exchange (NSE) and the Bombay Stock Exchange (BSE). The stock market is a key part of the secondary market, but over-the-counter (OTC) markets also fall into this category.

Elements of a Capital Market

Elements of a capital market include various participants, instruments, and regulatory bodies that work together to facilitate the buying and selling of financial securities. Here is a detailed overview: 


Suppliers of capital- Individual investors, institutional investors (such as mutual funds, pension funds, and insurance companies), and foreign investors.
Demanders of capital- Companies (both public and private), governments, and municipalities seeking funds for operations and growth. 

Financial Instruments

Equity instruments- Common stocks, preferred stocks.
Debt instruments- Corporate bonds, government bonds, municipal bonds, debentures.
Derivatives- Options, futures, swaps.
Hybrid instruments- Convertible bonds, preferred stocks with convertible features. 


Investment banks- Help companies issue new securities, underwrite IPOs, and provide advisory services.
Brokers and dealers- Facilitate the buying and selling of securities in the secondary market.
Asset Management Companies (AMCs)- Manage mutual funds and other pooled investment vehicles on behalf of investors.
Stock exchanges- Provide a platform for trading securities (e.g., BSE, NSE).
Clearing and settlement institutions- Ensure the proper transfer of securities and funds between buyers and sellers (e.g., Clearing Corporation of India).

Regulatory Bodies

SEBI- Regulates the capital markets in India.
RBI– Regulates and oversees the banking sector, which is integral to the capital markets.

Market Infrastructure

Trading platforms- Electronic and physical venues where securities are traded.
Clearinghouse- Institutions that facilitate the clearing and settlement of trades.
Depositories- Organisations that hold securities in electronic form, facilitating their transfer and settlement.

Functions of Capital Markets

Ensure Liquidity in the Economy
Capital markets provide liquidity by allowing investors to quickly buy and sell securities. This ensures that investors can easily convert their investments into cash when needed. 

Mobilise Funds
Capital markets channel savings from individuals and institutions into productive investments. This helps in pooling resources for businesses and governments. 

Aid in Business Growth
By providing access to capital, these markets enable businesses to raise funds for expansion, research, and development. This supports overall business growth and innovation.

Influence Security Prices
Capital markets play a role in determining security prices through supply and demand dynamics. However, it’s important to note that while market forces influence prices, regulatory bodies also play a significant role in ensuring fair and orderly markets.

Provide a Common Place for Buyers and Sellers
Capital markets serve as a centralised platform where buyers and sellers can trade financial securities. 

Provide Instruments for All Types of Investors
The capital markets offer a wide range of investment options, including stocks, bonds, mutual funds, and derivatives, catering to different risk appetites and investment goals.


Capital markets are very important aspects of the financial system. They facilitate the buying and selling of important financial securities, such as stocks and bonds. This not only ensures liquidity in the economy but also aids in fund mobilisation, contributing to the overall development of the economy.

Looking to Start Your Trading Journey?
Open a free Demat account on TradeSmart to enjoy low brokerage fees of only Rs.15 per executed order, regardless of the trade size or segment. Benefit from real-time support during market hours to make more informed decisions.

Disclaimer: The information contained in this article is solely for informational purposes and should not be construed as a stock recommendation or advice to buy or sell company shares. Stock market investing carries some risk. Therefore, before investing in shares, derivatives, or any other type of financial instrument traded on the exchanges, it is advisable to conduct thorough research or speak with an investment advisor.


What is the capital market vs. the stock market?
The stock market is just one part of the capital market. While the stock market deals with stocks specifically, the capital market includes stocks, bonds, and other forms of long-term capital.

What is the capital market and what are its types?
The capital market is a financial market where individuals and institutions trade financial securities such as stocks, bonds, and derivatives. It can be divided into primary and secondary markets based on the mode and choice of investment assets. 

What are the instruments of the capital market?
The capital market offers a variety of instruments for investment, including equity instruments, debt instruments, derivatives, and hybrid instruments. 

Who controls the capital market in India?
The capital market in India is regulated by the Securities and Exchange Board of India (SEBI) along with the Reserve Bank of India (RBI). 

Is the capital market safe?
Generally, investing in the capital market has certain risks, as the prices of securities can fluctuate. However, regulatory bodies like SEBI in India work to maintain market integrity and protect investors’ interests by enforcing rules and regulations.

" " " "


Open Demat Account With TradeSmart

Lowest Brokerage Ever Trade @15 Per Order
Download TradeSmart App Now

Scan below QR Code
to download App