Capital Markets
Capital markets are the platforms that facilitates transfer of capital from investors who want to employ their excess capital to businesses that require the capital to finance various projects or investments.
Types of Capital Markets
Primary Market: Where companies, governments or organisations raise new capital by issuing new securities like stocks and bonds.
Key Features:
First-time issuance of securities through IPOs, FPOs and Bonds and Private Placement to FIIs, DIIs and QIPs and Retail Investors.
Direct capital raising – Funds go to the issuer (company/government).
No trading – Investors buy directly from the issuer.
Primary Market Examples:
IPO: Tesla’s 2010 IPO at $17/share.
Corporate Bonds: Microsoft issuing new 10-year bonds.
Private Placements: A startup raising funds from VCs.
Secondary Market: Where already-issued securities (stocks, bonds, currency, derivatives, T Bill, CD, CP) are traded among investors.
Key Features:
Liquidity – Investors can buy/sell anytime.
Price discovery – Market-driven pricing (demand & supply).
No new capital raised – Only ownership changes hands.
Secondary Market Examples:
Stock Trading: Buying Amazon (AMZN) shares on NASDAQ.
Bond Trading: Selling U.S. Treasury bonds before maturity
Differences Between Primary and Secondary Market
| Description | Primary Market | Secondary Market |
| Meaning | Primary Market is the platform that offers security for the first time through IPO. | Secondary Market is the platform where investors trade already issued securities through IPO. Helps investors to make money. |
| Purpose | To enable companies to raise new capital through the issue of securities. | No capital raised. To facilitate trading of existing securities among investors. |
| Participants | Issuers (Companies, Governments), Merchant Bankers, Underwriters, Retail & Institutional Investors, Registrar, Collection Bank, Debenture Trustees and Portfolio Manager | Retail & Institutional Investors, Stockbrokers, Market Makers, Stock Exchanges |
| Another name | New issue market (NIM). | Share market. |
| Type of securities exchanged | Equity and Debt. | Equity, currencies, debt instruments, derivatives and mutual funds. |
| Type of product | Products are limited and mainly include IPO and FPO (Follow-on Public Offer). | Many products, such as shares, warrants, derivatives and more are available. |
| Price Determination | Determined by the issuing company. | Price is determined by forces of demand and supply. |
| Price Fluctuation | Price of security is fixed. | Price fluctuates continuously . |
| Frequency | Only once. | Securities are bought and sold continuously as long as they are listed on the Stock Exchange. |
| Liquidity | Low (one-time transaction). | High (continuous trading). |
| Regulation | Strict- Regulator and Companies Act. Due Diligence. | No issuer involvement. Regulator and Stock Exchange By-Laws. |
| Buyers | Directly from issuer (first-time sale). | From other investors. |
| Beneficiary | Company. | Investors. |
| How to identify investment | Investors primarily rely on Prospectus and word-of-mouth publicity to pick an investment in the primary market. | Research Analysts, Brokers, Investment Advisors and Financial Newspapers. |
| Physical Presence | There is no organization set up for the primary market. | Securities are traded on Stock Exchanges. There is a geographical setup and organizational presence for the secondary market. |
| Type of Company | Both Unlisted and Listed companies can issue new shares through IPO & FPO respectively. | Only Listed companies can trade shares. |
Capital Market Order Types
In capital markets, there are several types of orders that investors can use to buy or sell securities (stocks, bonds, ETFs, etc.). Each type of order specifies how and when the trade should be executed. Here are the most common types:
1. Market Order
- Executes immediately at the best available current market price.
- No price guarantee; execution is prioritized over price.
- Best for highly liquid stocks when speed is more important than price.
2. Limit Order
- Sets a maximum buy price or minimum sell price.
- Only executes if the market reaches the specified price (or better).
- Example: A buy limit order at $50 means the order will only fill at $50 or lower.
3. Stop Order (Stop-Loss Order)
- Becomes a market order once a specified stop price is hit.
- Used to limit losses (stop-loss) or lock in gains (stop-profit).
- Example: A stop-loss at $45 sells the stock if it drops to $45 or below.
4. Stop-Limit Order
- Combines a stop order and a limit order.
- Once the stop price is hit, it converts to a limit order (only executes at the limit price or better).
- Example: Stop at $45, Limit at $44 → If stock hits $45, it triggers a limit order to sell at no less than $44.
5. Trailing Stop Order
- A dynamic stop order that follows the stock price by a fixed amount or percentage.
- Used to protect profits while allowing upside potential.
- Example: A 10% trailing stop on a stock at $100 triggers a sell if the price drops to $90. If the stock rises to $120, the stop adjusts to $108 (10% below peak).
6. Immediate or Cancel (IOC) Order
- Executes immediately for any available quantity; unfilled portion is cancelled.
- Used when partial execution is acceptable.
7. Fill or Kill (FOK) Order
- Must be executed immediately in full or cancelled entirely.
- No partial fills allowed.
8. Good ‘Till Cancelled (GTC) Order
- Remains active until executed, cancelled, or expired (often 30-90 days, depending on the broker).
- Commonly used for limit and stop orders.
9. Day Order
- Only valid for the current trading day; expires if not filled.
10. All-or-None (AON) Order
- Requires the entire order quantity to be filled at once.
- Unlike FOK, it can wait in the order book.
11. Iceberg Order
- Large order split into smaller visible portions to hide the full size from the market.
- Used by institutional investors to avoid market impact.
12. Market-on-Close (MOC) & Limit-on-Close (LOC) Orders
- Executes at or near the closing price of the trading day.
- MOC = market order at close, LOC = limit order at close.
13. Pegged Order
- Automatically adjusts its price to track the market (e.g., pegged to the bid/ask or midpoint).
- Common in algorithmic trading.
Functions of Capital Market
(a) Allocation of Capital
One of the primary functions of capital markets is the efficient allocation of capital. Investors channel their savings into productive investments, enabling businesses to finance new projects, research initiatives and operational expansions. This allocation process fosters economic development by directing resources toward ventures with the highest potential returns.
(b) Risk Management
Capital markets offer diverse financial instruments, such as derivatives, which facilitate risk management for investors and businesses. Through options, futures, and swaps, market participants can hedge against adverse price movements, mitigate volatility, and safeguard their investments. By managing risks effectively, capital markets enhance market stability and investor confidence.
(c) Price Discovery
Capital markets serve as platforms for price discovery, where the forces of supply and demand interact to determine asset prices. Through continuous trading and information dissemination, markets reflect investors’ collective expectations, assessments of intrinsic value, and macroeconomic factors. Accurate price discovery ensures that assets are fairly valued, fostering efficient resource allocation.
(d) Facilitation of Economic Growth
By connecting investors with capital-seeking entities, capital markets play a pivotal role in fostering economic growth and innovation. Businesses utilize capital to fund research, develop new technologies and expand operations, driving productivity gains and job creation. Moreover, access to capital enables entrepreneurs to pursue entrepreneurial endeavours, spurring entrepreneurial activity and fostering a dynamic business environment.
(e) Liquidity Provision
Capital markets enhance liquidity by enabling investors to buy and sell securities freely. Liquid markets ensure that investors can exit positions quickly and at fair prices, promoting market efficiency and reducing transaction costs. Additionally, liquidity facilitates capital formation by attracting investors who seek readily tradable assets, thereby deepening market participation and fostering investor confidence.
(f) Capital Market Transactions
Companies maturing from a start-up to a larger company, need capital to finance their expansion. They normally raise the required capital either through equity markets or through debt markets.
Private Capital Market and Public Capital Market
The private capital market and public capital market are two distinct segments of the financial system where businesses and investors interact to raise and deploy capital. Private capital markets are suited for high-net-worth investors and institutions seeking high-growth (but risky) opportunities while public markets offer liquidity, transparency and accessibility to common investors. Companies often transition from private to public markets via an IPO when they seek broader capital access. Here are the key differences between them:
1. Definition & Participants
Private Capital Market:
- Involves transactions in privately held securities (not listed on public exchanges).
- Participants include private companies, venture capital (VC) firms, private equity (PE) funds, angel investors and institutional investors.
Public Capital Market:
- Involves trading of publicly listed securities on regulated exchanges (Examples: NYSE, NASDAQ, BSE SENSEX, NSE).
- Participants include retail investors, mutual funds, hedge funds, and institutional investors.
2. Regulation & Disclosure
Private Capital Market:
- Less regulated.
- Limited disclosure requirements (financials may not be publicly available).
Public Capital Market:
- Highly regulated (Example: SEC, FINRA, SEBI, Stock Exchange Rules).
- Strict disclosure mandates (quarterly earnings reports, insider trading laws).
3. Liquidity
Private Capital Market:
- Low liquidity, investments are illiquid, often locked in for years.
- Exit options include secondary sales, buybacks, or IPOs.
Public Capital Market:
- High liquidity, stocks/bonds can be sold instantly on exchanges.
- Investors can exit anytime at market prices.
4. Investment Size & Accessibility
Private Capital Market:
- Typically for accredited or institutional investors (high minimum investments).
- Not accessible to the general public.
Public Capital Market:
- Open to retail investors, can buy and sell shares with small amounts.
- More democratized access.
5. Risk & Return Profile
Private Capital Market:
- Higher risk (startups/private firms may fail).
- Potential for higher returns like VC-backed unicorns.
Public Capital Market:
- Generally lower risk due to diversification & transparency.
- Returns depend on market performance (S&P 500 averages).
6. Valuation & Pricing
Private Capital Market:
- Valuations are negotiated, less transparent.
- Based on funding rounds, pre-money/post-money valuation.
Public Capital Market:
- Prices determined by supply & demand in real-time.
- Market capitalization reflects investor sentiment.
7. Examples
Private Capital Market:
- Venture capital funding : Sequoia investing in a startup.
- Private equity buyout : Blackstone acquiring a private company.
Public Capital Market:
- Apple issuing shares on NASDAQ.
- Tesla bonds traded in the open market.
Best-known Capital Markets of the World
The world’s best-known capital markets are often synonymous with major financial centres where significant trading activity occurs, extensive liquidity prevails, and prominent companies are listed. These exchanges stand out due to their size, liquidity, regulatory frameworks and global prominence. Investors and companies often turn to these markets for capital raising, trading opportunities and benchmarking against global indices. Here are the top 10 stock exchanges in the world by market capitalization.
1. New York Stock Exchange (NYSE): As the largest stock exchange globally by market capitalization, the NYSE is synonymous with Wall Street and is home to numerous blue-chip companies. It’s known for its stringent listing requirements and iconic trading floor.
Location: New York, USA
Founded: 1792
Market Cap: $28.5 trillion
Key Indices: Dow Jones Industrial Average, S&P 500
Notable Listings: Apple, Microsoft, Berkshire Hathaway, Coca Cola
2. NASDAQ: This electronic stock exchange is renowned for its technology-focused listings, including many prominent tech giants like Apple, Amazon, and Microsoft. NASDAQ is known for its electronic trading platform and innovative market structure.
Location: New York, USA
Founded: 1971
Market Cap: $25 trillion
Key Indices: Nasdaq Composite, Nasdaq-100
Notable Listings: Amazon, Tesla, Alphabet (Google), Meta
3. London Stock Exchange (LSE): The LSE is one of the oldest stock exchanges globally and serves as the primary exchange for European equities. It’s known for its diverse listings, including multinational corporations and financial institutions.
Location: London, UK
Founded: 1801
Market Cap: $4.5 trillion
Key Indices: FTSE 100
Notable Listings: Shell, AstraZeneca, BP, Unilever, Barclays
4. Tokyo Stock Exchange (TSE): As the largest stock exchange in Japan, the TSE plays a crucial role in Asia-Pacific markets. It’s known for its robust regulatory framework and significant trading volumes in Japanese equities.
Location: Tokyo, Japan
Founded: 1878 (TSE); JPX in 2013
Market Cap: $6.8 trillion
Key Indices: Nikkei 225, TOPIX
Notable Listings: Toyota, Sony, SoftBank
5. Hong Kong Stock Exchange (HKEX): HKEX is a major hub for trading Chinese and international securities. It’s known for its strategic location bridging East and West markets and its role as a gateway to Mainland China’s capital markets.
Location: Hong Kong
Founded: 1891
Market Cap: $5.2 trillion
Key Indices: Hang Seng Index
Notable Listings: Alibaba, Meituan, Tencent, HSBC
6. Shanghai Stock Exchange (SSE): As one of China’s primary stock exchanges, the SSE is instrumental in China’s domestic capital market development. It’s known for its role in facilitating capital formation for Chinese companies.
Location: Shanghai, China
Founded: 1990
Market Cap: $7.6 trillion
Key Indices: SSE Composite
Notable Listings: PetroChina, ICBC, SAIC Motor
7. Euronext: Euronext operates multiple stock exchanges across Europe. It’s known for its diverse listings and pan-European market presence.
Location: Europe, Paris, Amsterdam, Brussels, Dublin, Lisbon, Milan.
Founded: 2000
Market Cap: $7.3 trillion
Key Indices: CAC 40 (France), AEX (Netherlands), Euronext 100
Notable Listings: LVMH, ASML, Airbus, L’Oréal
8. Frankfurt Stock Exchange (FWB): As Germany’s primary stock exchange, FWB is a key player in European capital markets. It’s known for its role in trading German equities and its integration into global financial markets.
Location: Frankfurt, Germany.
Market Cap: $2.6 trillion
Founded: 1585
Key Indices: DAX 40
Notable Listings: Siemens, SAP, Volkswagen
9. Shenzhen Stock Exchange (SZSE): Shenzhen Stock Exchange (SZSE) is one of two main stock exchanges operating independently in mainland China. Smaller and emerging-sector companies trade on SZSE.
Location: Shenzhen, China
Market Cap: $5.5 trillion
Founded: 1990
Key Indices: SZSE Component Index
Notable Listings: Tencent (partially listed), BYD, Ping An Bank, Vanke
10. Bombay Stock Exchange (BSE):It is one of the oldest and largest stock exchanges in the world, playing a crucial role in India’s financial markets. It is the largest stock exchange of the world by number of listings. It is part of MSCI Emerging Markets Index.
Location: Mumbai, India
Founded: 1875
Market Cap: $5.35 trillion
Key Indices: S&P BSE SENSEX , BSE 500, BSE MidCap & SmallCap
Notable Listings: Reliance Industries, TCS
11. National Stock Exchange of India (NSE): India’s largest and most technologically advanced stock exchange, dominating equity and derivatives trading. Controls 95%+ of India’s derivatives trading.
Location: Mumbai, India
Founded: 1992
Market Cap: $5.13 trillion
Key Indices: NIFTY 50, NIFTY IT, NIFTY Bank, NIFTY 50, NIFTY Midcap 100 & Smallcap 100
Notable Listings: HDFC Bank, Infosys, Reliance, TCS, SBI, ICICI Bank.
Derivatives
Derivatives are financial contracts whose value is derived from an underlying asset, such as stocks, bonds, commodities, currencies, or market indices. Derivatives are used for hedging or speculation or arbitrage. The four different types of derivatives are as follows:
- Forward Contracts
- Future Contracts.
- Options Contracts.
- Swap Contracts.
They can be further divided into 4 major derivative categories as given below:
- Equity derivatives
- Index derivatives
- Commodity derivatives
- Currency derivatives
Purpose of Derivatives Trading
Hedging Risk: Derivatives are valuable tools for managing risk. Investors use them to hedge against unfavourable price movements in underlying assets. For example, a wheat farmer can use futures contracts to lock in a selling price to protect against potential price declines.
Speculation: Some investors enter into derivative contracts to speculate on the future price movements of underlying assets. They seek to profit from these price changes without owning the actual asset. Derivatives allow for leveraged positions, potentially magnifying gains or losses.
Portfolio Diversification: Derivatives can be used to diversify investment portfolios. By adding assets like options or futures to a portfolio of stocks and bonds, investors can spread risk and reduce the correlation between their holdings.
Leverage: Derivatives offer the potential for substantial profits with a relatively small upfront investment, thanks to leverage. Traders can control larger positions than they could with the same amount of capital invested directly in the underlying asset. However, leverage also increases the risk of significant losses.
Income Generation: Some investors use options strategies like covered calls or cash-secured puts to generate income. They receive premiums for selling options contracts and may benefit from the passage of time or reduced volatility.
Arbitrage Opportunities: Arbitrageurs seek to profit from price disparities between related assets in different markets. Derivatives enable them to simultaneously buy and sell these assets to exploit price differences, effectively eliminating risk.
Tax Efficiency: In some cases, derivatives can offer tax advantages. For instance, certain types of options may have more favourable tax treatment than direct ownership of the underlying asset.
Participants in the Derivative Markets
(1) Hedgers: Hedgers use derivatives to minimise the risk of adverse price movements in the underlying asset.
(2) Speculators: Speculators seek to profit from anticipated price changes in the underlying asset. They take on increased risk in hopes of earning a higher return.
(3) Arbitrageurs: Arbitrageurs seek to profit from price differences between different markets for the same asset. For example, they may buy a currency at one exchange rate and then sell it immediately at a higher rate in another market.
(4) Market Makers: Market makers provide liquidity by quoting bids and asking prices for derivatives contracts. They also facilitate trades between buyers and sellers.
Cash Market vs Derivatives Market
| Feature | Cash Market | Derivatives Market |
| Also Known As | Spot Market | Futures & Options Market |
| Type of Transaction | Immediate settlement of securities | Contract for future settlement |
| Underlying Asset | Actual securities (stocks, bonds) | Contracts based on underlying assets |
| Ownership | Buyer gets ownership of the asset | No ownership, only right/obligation based on contract terms |
| Settlement | T+1 or T+2 (typically next day or two) | On expiry date or mark-to-market daily |
| Purpose | Investment or actual buying/selling | Hedging, speculation, or arbitrage |
| Risk Level | Generally lower | Higher due to leverage and price volatility |
| Leverage | No or minimal leverage | High leverage (margin trading allowed) |
| Market Participants | Long-term investors, retail traders | Hedgers, speculators, institutional traders |
| Examples | Buying 100 shares of TCS today | Buying a NIFTY futures contract expiring next month |
Differences Between Futures and Forwards
1.Futures are standard instruments, governed by Stock Exchanges rules and regulations, size, amount, settlement date while Forwards are traded OTC between two parties & determined by private parties and varies from contract to contract.
2.Futures normally do not have Credit Risk as they are settled through Exchange’s Clearing House where Daily mark-to-market and margining are automatically required while Forwards carry both Credit Risk and Market Risk.
3.Futures are settled at the settlement price fixed on the last trading date of the contract (i.e. at the end). Forwards are settled at the Forward price agreed on at the trade date (i.e. at the start).
4.Futures are generally subject to a single regulatory regime in one jurisdiction, while forwards – although usually transacted by regulated firms – are transacted across jurisdictional boundaries and are primarily governed by the contractual relations between the parties.
Difference Between Options and Futures
1. An option gives the buyer the right, but not the obligation to buy (or sell) a certain asset at a specific price at any time during the life of the contract. A futures contract gives the buyer the obligation to purchase a specific asset, and the seller to sell and deliver that asset at a specific future date, unless the holder’s position is closed prior to expiration.
2.No upfront cost needs to be paid in Futures whereas buying an Options position does require the upfront payment of a premium by Buyer to Seller.
3.Generally, the underlying position is much larger for Futures contracts, and the obligation to buy or sell this certain amount at a given price makes futures more risky for the inexperienced investor.
4.The final major difference between these two financial instruments is the way the gains are received by the parties. The gain on a option can be realized by exercising the option when it is deep in the money, going to the market and taking the opposite position or waiting until expiry and collecting the difference between the asset price and the Strike Price. In contrast, gains on futures positions are automatically ‘marked to market’ daily, meaning the change in the value of the positions is attributed to the futures accounts of the parties at the end of every trading day – but a futures contract holder can realize gains also by going to the market and taking the opposite position.