Capital Market - Primary Market and Secondary Market [Finance Notes for AHSEC Class 12 2024 Exam]

Unit 3: Capital Market
Primary Market and Secondary Market
[Finance Notes for AHSEC Class 12 2024 Exam]

OBJECTIVE QUESTIONS (1 mark) – Both Capital Market and Money Market

1. What is a financial market? Mention its components.                              2008

Ans: It refers to a market which creates and exchanges financial assets and credit instruments such as cheques, bills, bonds, deposits etc. It is divided into two parts: Money market and capital market.

2. What are financial assets?

Ans: It refers to the financial instruments or securities. For e.g. shares, debentures, treasury bills, commercial paper etc.

3. What is floatation cost?

Ans: The expenditure incurred in issuing the securities is called floatation cost.

4. What is a zero coupon bond?

Ans: It is a financial instrument for which no interest is paid but is issued at a discount redeemable at par.

5. State the components of capital market?

Ans: a) Primary market b) secondary market.

6. Name two buyers of Commercial paper.

Ans: a) Banks b) Insurance companies.

7. What is meant by “Near Money?”

Ans: All very short term securities are called near money for e.g. marketable securities.

8. What type of trade-off function is performed by the money market?

Ans: The money market establishes a balance between short term financial supply and short term financial demand.

9. Name the instruments that are traded in money market.                        2013

Ans: Call money, Commercial Papers, Certificates of deposits, Bills of exchange.

10. Name the instruments that are traded in capital market.

Ans: Stocks, Shares, Debentures, Bonds, GDR (Global Depository receipts)

11. Name the institutions operating in the money market.

Ans: Central Bank, Commercial banks, Non-bank financial institutions.

12. Name the institutions operating in the capital market.

Ans: IDBI, IFCI, ICICI, Stock exchanges.

13. In which year NSEI and BSE were established?                           2015

Ans: NSEI – In 1991 and BSE – In 1875. But, NSEI was recognized in 1992.

14. In which year OTCEI was established?

Ans: 1990

15. Write the full form of NSEI, BSE and OTCEI.                  2008

Ans: NSEI – National stock exchange of India (Nifty)-Nov, 1992

BSE – Bombay Stock Exchange (Sensex) – 1875 (Oldest Stock exchange of India)

OTCEI – Over the Counter Exchange of India – October, 1990

16. State two promoters of NSEI.

Ans: a) Industrial development bank of India (IDBI) b) Life insurance corporation of India (LIC)

17. How many stock exchanges are there in India?

Ans: There are 24 stock exchanges in India.

18. Name two advisory committees set up by SEBI.

Ans: a) Primary market Advisory committee. b) Secondary market advisory committee.

19. What is price rigging?

Ans: It refers to the manipulation of prices of the securities by agents/company for their own profits.

20. On what lines was OTCEI started?

Ans: It was started on the lines of NASDAQ (National Association of securities Dealers Automated Quotation)

21. Name the system where there is electronic book entry form of holding and transferring the securities.

Ans: Dematerialisation.

22. What is ‘Demutualisation of securities?’

Ans: It separates the ownership and control of stock exchanges from trading rights.

23. Name the Benchmark index of BSE.

Ans: SENSEX.

24. Stock exchange is called economic barometer.

Ans: True

25. State the segments of NSEI.

Ans: a) Wholesale debt market b) Capital market segment

26. State one development function of SEBI

Ans: to carry out research work.

27. Capital Market is the market for long term funds and money market is the market for short term funds? T/F

Ans: Given statement is true.                                      2010, 2012, 2013

28. Give some examples of Primary assets and secondary assets.

Ans: Primary assets includes shares, debentures and bonds and secondary assets includes mutual funds, bank deposit, insurance etc.

29. What are government securities or gilt edged securities market?

Ans: In this market, market issue gild edged securities such as TBs, Bonds and dated securities to raise money from public.

30. What is industrial securities market?

Ans: It refers to market for issue of securities for existing as well as new companies.

Q.1. What is Capital Market? What are its components? Explain features and importance. 2014, 2016, 2020

Ans: Capital Market is generally understood as the market for long-term funds. This market supplies funds for financing the fixed capital requirement of trade and commerce as well as the long-term requirements of the Government. The long-term funds are made available through various instruments such as debentures, preference shares and equity shares. The capital market can be local, regional, national, or international. 99, 04, 08,09,11,14

The capital market is classified into two categories (Components), namely,

(i)      Primary market or new issue market, and

(ii)    Secondary market or stock exchange.

Features of Indian Capital Market                            2015, 2018, 2022

a)       Dealing in Securities: It deals in long-term marketable securities and non-marketable securities.

b)      Segments: It included both primary and secondary market. Primary market is meant for issue of fresh shares and secondary market facilitates buying and selling of second hand securities.

c)       Investors: It includes both individual investors and institutional investors such as Mutual funds, banks, Insurance companies etc. It also includes foreign institutional investors.

d)      Link between savers and investment opportunities: Capital market is a crucial link between saving and investment process. It facilitates flow of long term capital from those who have surplus capital to those who need capital.

e)      Intermediaries: It acts through intermediaries which includes bankers, brokers, underwriters etc.

f)        Government rules and regulations: The capital market operates freely but under the guidance of government policies. These market functions within the framework of government rules and regulations.

Functions and Importance of Capital Market

a)      Availability of funds: Capital market helps to raise long term funds from both domestic and as well as foreign institutional investors.

b)      Mobilization of savings: Capital market mobilizes the savings of individuals and institutions to productive channels. It facilitates flow of long term capital from those who have surplus capital to those who need capital.

c)      Industrial growth: it plays a significant role in the economic development of a country. It facilitates increase in production and productivity in the economy and hence enhances the economic welfare of the society.

d)      Stability in security prices: The Capital market tends to stabilize the values of stocks and securities and reduce the fluctuations in the price to the minimum. The process of stabilization is facilitated by providing capital to the borrowers at a lower interest rate and reducing the speculative and unproductive activities.

e)      Liquidity: It provides liquidity to investors in capital market. The securities issued through the primary market are traded in the secondary market which provides liquidity to the investors and also short-term as well as long-term yields on their investments.

f)       Promotion of economic growth: The capital market not only reflects the general conditions of the economy, but also smoothens and accelerates the process of economic growth. Various institutions of the capital market allocate the resources rationally in accordance with the development needs of the country.

g)      Balance between demand and supply: It bring about balance between demand and supply of capital by creating a link between those who demand capital and those who supply capital.

h)      Attracting foreign capital: Capital market helps in attracting foreign investments. The Indian capital market provides the channel through which foreign institutional investors and NRIs ca invest their funds in the securities of Indian companies.

Q.2. What is primary and secondary market (Stock Exchange – 2015)? State four differences between primary market and secondary Market.

Ans: Primary market (2014,2016) which is also called new issue market represents a market where new securities i.e. share, debentures and bonds that have never been previously issued are offered. It is a market of fresh capital. The main function of this market is to facilitate the transfer of funds from willing investors to the entrepreneurs who need funds. but with the changing time, the nature of primary market is also changing. There exist two types of primary market:

a)       Market where firms issue securities for the first time through Initial Public Offer (IPO).

b)      Market where firms which are already trading in secondary market raise additional capital through Seasoned Equity Offering (SEO).

Secondary market also called stock exchange represents a market where existing securities i.e. shares and debentures are traded. Its main function is to create a link between the buyers and sellers of securities so that investments can change hands in the quickest and cheapest manner.

According to Securities Contract (Regulation) Act, 1956, the term stock exchange has been defined as, “an association, organisation or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities.”

Thus, a stock market is a market where dealings in the listed securities are made by the members of the exchange on their own behalf or on behalf of others.

From the above explanation it is clear that there are some differences between primary and secondary market which are given below:

Basis	Primary Market	Secondary Market
1. Meaning	It is the market where the securities are issued for the first time. It is also referred as New issue market.	It is the market where the existing securities are traded. It is also called stock Exchange.
2. Price determination	The prices of the securities are determined by the company.	The prices of the securities are determined by the forces of demand and supply of the securities.
3. Buying and selling	Here, only buying of the securities take place.	Here, buying and selling of the securities, both take place.
4. Participants	Securities are sold by the company directly to the investors.	Securities are traded by the investors. Company is not involved in trading.
5. Purpose	Purpose of primary market is to provide capital for setting new business.	The main purpose of secondary market is to provide liquidity to the investors.
6. Capital formation	Primary market promotes capital formation directly.	Capital market promotes capital formation indirectly.

Q.3. What is Primary Market? What are the functions of Primary market?

Ans: Primary Market (New Issue Market): A primary market refers to any market where new shares of stock are sold. The primary market is the entry market for companies and investors, where a company or institution that requires initial or additional capital sells its shares or financial instrument to the investors. For example, Initial Public Offering (IPO), public offer, rights issue and bond issue are done on the primary market.

The primary market is also unique that the initial buyer is the only person who can exchange the securities for funds. When companies are willing to go for publicly listed on the stock exchange and wants to collect funds from general investors, they first sell their financial instrument in the primary market. Primary market is the first place for trading financial instruments including stocks and bonds.

Functions of Primary Market

The main function of a primary market can be divided into three service functions. They are: origination, underwriting and distribution.

1. Origination: Origination refers to the work of investigation, analysis and processing of new project proposals. Origination begins before an issue is actually floated in the market. The function of origination is done by merchant bankers who may be commercial banks, all India financial institutions or private firms.

2. Underwriting: When a company issues shares to the public it is not sure that the whole shares will be subscribed by the public. Therefore, in order to ensure the full subscription of shares (or at least 90%) the company may underwrite its shares or debentures. The act of ensuring the sale of shares or debentures of a company even before offering to the public is called underwriting. It is a contract between a company and an underwriter (individual or firm of individuals) by which he agrees to undertake that part of shares or debentures which has not been subscribed by the public. The firms or persons who are engaged in underwriting are called underwriters.

3. Distribution: This is the function of sale of securities to ultimate investors. This service is performed by brokers and agents. They maintain a direct and regular contact with the ultimate investors.

Q.4. List out various intermediaries of New Issue Market?

Ans: The Primary Market is primarily associated with the issuance of new securities, such as stocks and bonds, by companies and governments to raise capital. In this market, financial intermediaries play various roles, but their functions are not typically described in terms of Net Interest Margin (NIM). Instead, they facilitate the issuance and distribution of securities to investors. Key intermediaries in the Primary Market include:

a) Investment Banks: Investment banks assist companies and governments in the process of issuing new securities. They help in underwriting the offerings, pricing the securities, and marketing them to potential investors.

b) Underwriters: Underwriters commit to purchasing the securities from the issuer at a specific price and then sell them to investors. They assume the risk associated with selling the securities to the public.

c) Brokerage Firms: Brokerage firms facilitate the buying and selling of securities in the Primary Market. They often act as intermediaries between investors and the underwriters or issuers.

d) Regulatory Authorities: Regulatory bodies, such as the Securities and Exchange Board of India (SEBI) in India, oversee and regulate the Primary Market to ensure transparency, fairness, and investor protection.

e) Issuers: Companies, government entities, and other organizations seeking to raise capital through the issuance of securities are also participants in the Primary Market.

f) Individual and Institutional Investors: Investors, both individual and institutional (such as mutual funds, pension funds, and insurance companies), participate in the Primary Market by purchasing newly issued securities.

Q.5. Mention various methods of issue or raising capital in the New issue market?

Ans: Mode of raising capital in the Primary market

1.    Public issue/Prospectus: Securities are issued to the general public. This is the most popular method of raising long term fund. In this method securities are offered to the public by issuing prospectus.

2.    Right issue: The equity shares of a company are issued to the existing equity shareholders in the form of right issue. In this issue additional securities are offered to the existing shareholders.

3.    Private placement: Under private placement the shares of a company are sold among the selected group of persons.

4.    Offer for Sale Method: Under this method, instead of offering shares directly to the public by the company itself, it offers through the intermediary such as issue houses / merchant banks / investment banks or firms of stock brokers.

5.    Other Methods of Issuing Securities: Apart from the above methods, there are some other methods of issuing securities. They are:

a.    Tender method: Under tender method, the issue price is not predetermined. The company announces the public issue without indicating the issue price. It invites bids from various interested parties. The parties participating in the tender submit their maximum offers indicating the maximum price they are willing to pay. They should also specify the number of shares they are interested to buy. The company, after receiving various offers, may decide about the price in such a manner that the entire issue is fairly subscribed or sold to the parties participating in the tender.

b.    Issue of bonus shares: Where the accumulated reserves and surplus of profits of a company are converted into paid up capital, it is called bonus issue. It simply refers to capitalization of existing reserves and surpluses of a company.

c.     Offer to the employees: Now a day’s companies issue shares on a preferential basis to their employees (including whole time directors). This attracts, retains and motivates the employees by creating a sense of belonging and loyalty. Generally, shares are issued at a discount. A company can issue shares to their employees under the following two schemes: (a) Employee stock option scheme and (b) employee stock purchase scheme.

d.    Offer to the creditors: At the time of reorganization of capital, creditors may be issued shares in full settlement of their loans.

e.    Offer to the customers: Public utility undertakings offer shares to their customers.

Q.6.  What are the merits and demerits of New Issue Market (NIM)?

Ans: Available in our mobile application

Q.7. What is stock exchange? Mention its features. “Stock exchange is the barometer of the economy” In the light of the statement, discuss the functions of the stock exchange. 

Ans: STOCK EXCHANGE (2013): A stock exchange is highly organised financial market where the second hand securities can be bought and sold. Its main functions are to create a link between the buyers and sellers of securities so that investments can change hands in the quickest, cheapest and fairest manner. Under the Securities Contract (Regulation) Act, 1956, the term stock exchange has been defined as “as association, organisation or body of individuals, whether incorporated or not, established for the purpose of assisting, regulating and controlling business in buying, selling and dealing in securities”.                     2013,

FEATURES OF STOCK EXCHANGE

The important features of stock exchange are as follows –

a)       Stock exchange is a market where dealings take place in shares, debentures and bonds issued by the company’s corporations, government, etc.

b)      Only those securities could be traded that are included in the official list of stock exchange.

c)       It also deals in government securities.

d)      Stock exchange is organisation in the form of an association or a company or a body of individuals.

e)      It is a common meeting place of buyers and sellers of second hand securities.

f)        In stock exchanges, brokers serve as a link between the buyers and sellers.

g)       Stock exchanges frame their rules and regulations.

h)      The areas of operations of stock exchange or geographical jurisdiction is well defined.

i)        In India, stock exchanges operate as per guidelines issued by the Securities and Exchange Board of India.

Functions of stock exchange                       08, 09, 10, 12, 14, 2016, 2018, 2019, 2022

As the barometer measures the atmospheric pressure, the stock exchange measures the growth of the economy. It performs the following vital functions:

1.       Ready market and liquidity: Stock exchange provides a ready and continuous market where investors can convert their money into securities and securities into money easily and quickly. It provides a convenient meeting place for buyers and sellers of securities.

2.       Evaluation of securities: Stock exchange helps in determining the prices of various securities that reflect their real worth. The forces of demand and supply act freely in the stock exchange and help in the valuation of securities.

3.       Mobilisation of savings: Stock exchange helps in mobilising surplus funds of individuals and institutions for investment in securities. In the absence of facilities for quick and profitable disposal of securities, such funds may remain idle.

4.       Capital formation: Stock exchange not only mobilises the existing savings but also induces the public to save money. It provides avenue for investment in various securities which yield higher returns. It helps in allocation of available funds into the most productive channels.

5.       Regulation of corporate sector: Stock exchanges frame their rules and regulations. Every company which wants its securities to be dealt in at the stock exchange has to follow the rules framed by the stock exchange in this regard.

6.       Economic barometer: Stock exchange is very sensitive barometer of business conditions in the country. Booms, depressions and other important events affect prices of securities. Price trends on the stock exchange reflect the economic climate in the country. One can easily analyse the cause of change in the business climate by the ups and downs on the stock exchange.

7.       Encourages Industrialization: The stock exchange provides capital to industry and commerce. They provide finance to the Govt.

8.       Helps government in the Policy Formulation: All the government policies have their clear reflection on the national science through stock exchange whether they are economic policies or monetary or fiscal.

Q. 8. Mention various types of operators in stock exchange.

Ans: Types of operators in Stock Exchange

1. Brokers: A broker is a member of the stock exchange who buys and sells securities on behalf of investors. He charges brokerage or commission for his services.

2. Jobber: A jobber also known as Tarawaniwala is a member of the stock exchange who is specialised in one type of security and buys and sells securities on his own behalf.

3. Bulls: A bull is a speculator who buys securities expecting higher prices in future.

4. Bears: A bear is a speculator who sells securities expecting fall in prices in near future.

5. Stag: A stag is a speculator who applies for new securities in expectation that prices will rise by the time of allotment and he can sell them at premium.