You might have often heard the word “money market,” or “capital market.” Perhaps, you might have come to your own conclusions that a money market or capital market is someplace where you can get money such as loans or finance, invest or divest, trade-in stocks and Exchange Traded Funds or buy Mutual Funds and deal in foreign currencies.
Actually, this is not the exact definition, though it is correct to a great extent. Actually, the term money market refers to two types of capital markets in India.
In this article, I will discuss about the two types of markets that exist in India in 2021. And they’ve been around since pretty long. Therefore, this information could help you the next time you’re thinking about investments.
Difference between money market and capital market
What is Money Market?
Whenever companies or businesses require extra money, they go to the money market. At the money market, they raise funds for short-term use by using various means such as pledging an asset they hold to a bank, hypothecation of machinery and other infrastructure or even taking direct loans.
And in some cases, larger companies also take short-term loans from banks. However, if the amount is too large, the bank forms a consortium with other lenders to provide the funds to that organization.
In return, the company or organization agrees to pay a specific rate of interest on the money it takes from a single bank or a consortium of lenders.
In most cases, companies use the money market only when they’re confident of repaying the loans or debts within a specific period of time. That’s because they need the money urgently but for a short span of time only to fund a new project or expansion of their business.
Usually, the borrowing company would have adequate resources to repay loans taken from the money market. Hence, they find it easy to get short term finance, which is usually for a one-year or two-year duration only.
What is Capital Market?
However, when a company or organization requires really large amounts of money, they go to the capital market.
As the term signifies, they do so to get capital for their long-term plans and projects that would see their business grow exponentially. Such capital has a time span of more than one or two years.
To raise funds from the capital market, companies issue capital market bonds such as debentures, stocks, debt instruments, derivative market instruments, Exchange Traded Funds, Futures, Options, among other things.
They ensure their investors get returns for their money over an extended period of time that can stretch beyond two years.
There’re two different types of capital markets in India. In this article, I will explain all about these two types and how companies raise funds using these capital markets.
1. Primary Market
The primary market gets its name because that’s the first place where organizations go to raise large amounts of money. There’re four ways to get money from a primary market that companies use.
1. Initial Public Offering
Initial Public Offering is generally when a company offers its stocks for sale to individual and corporate investors. To launch an IPO, the company requires clearance from the Security and Exchanges Board of India (SEBI), Ministry of Finance and other authorities.
These authorities will only give them permission to launch an IPO to solicit funds from individual and corporate investors if they find all things are in place and the company seeking money isn’t making false claims.
When an IPO opens, people and other companies can subscribe to it either offline or through e-IPOs which is online.
You can subscribe to an IPO by filling in various details such as your name, address, Central Know Your Customer (CKYC) number, Demat account number and bank details on a physical IPO form. This form can be submitted to your bank or mailed with a check.
Generally, an IPO and e-IPO stipulate the minimum number of shares you need to bid for, to qualify. And then there’s a premium added on the original share value, which differs according to the company and the business.
When an IPO or e-IPO closes, investors that bid successfully are given their shares electronically, on their Demat accounts.
Once an IPO is allotted, the shares open for trading on the stock markets.
2. Employee Stock Ownership Plan
Generally smaller businesses and startups that require more money offer the Employee Stock Ownership Plan or ESOP. This is also a way to promote productivity and make employees as the part owners of the company.
In such cases, the owners of the company decide how much funds they require. They make stocks of the company and offer them to their employees. The amount of money they need is thus raised through money their employees pay to buy the stocks or if the employee desires, through salary deductions.
In such cases, there’re no external shareholders of the company. Usually, those working at the organization at senior positions get more stocks than those in lower rungs of the echelon. Additionally, employees can also bid to buy more stocks, if they have the money up-front.
There’re also cases where company employees get preferential treatment in the allocation of shares during an IPO, if the organization opts to raise funds from the public too.
3. Closed Holdings or Private Placements
There’re several organizations that don’t wish their stocks to fall into the public’s hands. Hence, they offer their sticks to specific companies and financial institutions only. In such cases, the system is known as closed holdings or private placements.
Usually, the organization that needs to raise funds will invite several companies to invest and buy their stocks. They will allot shares to the highest bidder that buy the largest number of stocks.
This is one way to ensure that the company continues to get funding from its shareholders, if necessary. At the same time, there’re no guarantees that one or more companies that hold the stocks would sell them to other organizations at higher prices and exit the closed holdings.
This could result in what’s termed a “hostile takeover,” since one organization will hold controlling stocks in that business.
4. Rights Issue
A Rights Issue is when a company decides to sell more of its stocks at the original price to its investors in its IPO. This usually happens when a company is performing well and needs long-term funds for expansion and growth or to open new projects.
They will offer these stocks on a first-come-first-served basis only. And if there’re no investors available, the Rights Issue can be opened to the public for investments. In such cases too, the price of the stock is similar to that of an IPO.
2. Secondary Market
The secondary market comes into play when a company already has stocks listed on the stock markets. Now, all it needs to do is maintain its market capitalization. That means, performing well to ensure that stockholders don’t lose their money while the prices of their shares run higher. Here’re the topmost examples of the secondary market.
1. Stock Markets
When you want to buy shares that’re already trading on the stock markets, you’re actually approaching the secondary market. There’re two main secondary markets in India- the Bombay Stock Exchange (BSE) and the National Stock Exchange (NSE). Here, you cannot buy and sell stocks directly. Instead, you would require a Demat account with a trading facility.
2. Mutual Funds
Mutual Funds always open as New Fund Offers. That means, there’re no stocks in the NFO. Hence, each unit of a Mutual Fund is sold at Rs.10 only. However, Mutual Fund houses decide the amounts of minimum subscriptions for their NFOs. Often, it’s between Rs.500 and Rs.5,000, with multiples of Rs.10 each.
Once the NFO closes for subscriptions, the Funds Managers buy stocks from the secondary market and monitor their performance. They buy and sell stocks to ensure that investors in NFOs and those buying later get adequate, high returns.
3. Exchange Traded Funds
Exchange-Traded Funds are also a form of Mutual Funds. They also consist of a bunch of stocks of various companies. However, unlike Mutual Funds, an ETF is traded daily on the stock market. Hence, its price can drop or rise, depending on the performance of stocks in its portfolio.
ETFs are one more way that investors can put money into several stocks, including very expensive ones, indirectly, through the secondary market. In fact, ETFs also open as NFOs. However, you’ve to subscribe to them through your Demat and trading account or directly from the financial institution.
The Government of India also issues some ETFs. Classic examples include the Central Public Sector Enterprises (CPSE) ETF and Bharat 22 ETF. The CPSE ETF is managed by Reliance Asset Management while Bharat 22 is from ICICI Prudential Asset Management.
4. Further Fund Offers
If a Mutual Fund needs to get money to invest in a successful fund or ETF, it launches something called a Further Funds Offer or Series of the same Mutual Fund. This way, investors that wish to buy more ETF units or Mutual Fund units can do so at a lower price.
Furthermore, FFOs and Series also provide opportunities for investors that missed the NFO to invest in an ETF or Mutual Fund that’s performing well.
The above explanations and descriptions of the popular types of capital markets in India in 2021 would help you plan your investments. Further, you might get questions related to money markets and capital markets during an interview or entrance exam for banks and financial institutions.
Therefore, this article could help you in several ways. Additionally, learning about the various kinds of capital markets and money markets can further your general knowledge too.