Capital Market: Types, Debt Market Instrument, & Terminologies

Introduction

It refers to the market for funds with a maturity of 1 year or more; Include the equity (stock) market and debt (bond) market. RBI regulates the long-term government securities while the long-term corporate debt market comes under the purview of the Securities Exchange and Board of India (SEBI).  [UPSC 2023]

Types of Capital Market

Ways to Raise Capital in the Primary Market

• Public Issue: Open for all Indian citizens, the most broad-based method of raising capital and the most prestigious. 
• Rights Issue: Raising capital from the existing shareholders of a company – preferential kind of issue restricted to a certain category of the public only. 
• Private Placement: When a company issues financial security such as shares and convertible securities to a particular group of investors (not more than 49 in number).

Different Types of Capital

• Authorized Capital: It is the maximum number of shares a company is legally allowed to issue. 
• Issued Capital: Shares that have actually been issued by the company to the shareholders. 
• Subscribed Capital: A portion of the authorized capital that potential shareholders have agreed to purchase from the company’s treasury. 
• Paid-up Capital: Portion of the subscribed capital for which the company has received payment from the subscribers.

Instruments of Capital Market

Debt Market Instrument

• Bond: A loan that is secured by a specific physical asset;  
  • Have lower interest rates compared to debentures.
• Masala bonds: Issued by Indian entities outside India but denominated in Indian Rupees. 
• Fixed Rate Bonds: These are bonds on which the coupon rate is fixed for the entire life (i.e. till maturity) of the bond.
• Floating Rate Bonds: it has a variable coupon rate which is reset at pre-announced intervals (say, every six months or one year.
• Perpetual Bonds/Consol Bonds: Issuers do not have to return the principal amount to the purchaser. 
  • This investment type does not have any maturity period, and customers benefit from steady interest payments for perpetuity.
• Zero Coupon Bonds: Sold on discount and repurchased at face value, rendering a profit at maturity.
  • It pays no interest as such. [UPSC 2020]
• Bearer Bonds: A  fixed-income security that is owned by the holder, or bearer, rather than by a registered owner.
• Capital Indexed Bonds : These are bonds, the principal of which is linked to an accepted index of inflation with a view to protecting the Principal amount of the investors from inflation.
• Inflation Indexed Bonds (IIBs) – Bonds wherein both coupon flows (Interest) and Principal amounts are protected against inflation. 
  • Government can reduce the coupon rates on its borrowing by way of IIBs.
  • The existing tax provisions will be applicable on interest payment and capital gains on IIBs. [UPSC 2022]
• Bonds with Call/ Put Options: Bonds can also be issued with features of optionality wherein the issuer can have the option to buy-back (call option) or the investor can have the option to sell the bond (put option) to the issuer before the maturity of the bond.
• Negative Yield Bonds: Debt instruments that pay the investor a maturity amount lower than the purchase price of the bond; 
  • They attract investments during uncertain times as investors look to protect their capital from significant erosion.
  • Special Zero-Coupon Recapitalization Bonds 
  • These are special types of bonds issued by the Central government specifically to a particular institution.
  • Only those banks, whosoever is specified, can invest in them, nobody else. 
  • Not tradable, nor transferable.
  • limited only to a specific bank, and it is for a specified period.
  • It is zero coupon, issued at par and will be paid at the end of the specified period.
  • The issuance of these special bonds will not affect the fiscal deficit while at the same time provide much needed equity capital to the bank.
• Uday Bonds 
  • To reduce the debt burden of the DISCOMs wherein the states would take over some percentage of their Debt obligations of the DISCOMs. 
  • In return, the DISCOMs are required to implement structural reforms in order to improve their financial viability. 
  • The government issues UDAY bonds to banks and other financial institutions to raise money to pay off the banks.
• Maharaja Bonds: Rupee-denominated bonds issued by International Finance Corporation (IFC) in India’s domestic market.
• Muni Bonds: Bonds issued by Urban Local Bodies (ULB) to raise money for the development of various capital-intensive infrastructure projects. 
  • Example:  Bengaluru Municipal Corporation issued municipal bonds for the first time.
• Elephant Bonds: Proposed by Surjit Bhalla Committee. 
  • People declaring undisclosed foreign income will be required to invest at least 50% in the Elephant Bonds to be used for financing Infrastructure.
• Impact Bonds: Unsecured bonds to raise funds towards a project with a social impact or development impact.
• Sovereign Gold Bonds: Government securities denominated in grams of gold; 
  • Investors pay the issue price in cash and the bonds will be redeemed in cash on maturity. 
  • Eligibility: Only resident Indian entities, including individuals, HUFs, trusts, universities and charitable institutions.
• Green Bonds: Proceeds of such Bonds are exclusively used for financing green projects such as renewable energy projects, climate change, reducing fossil fuel emissions etc. 
• First Green Bond Issued by European Investment Bank in 2007 – Climate Awareness Bond.
• Panda Bonds: Yuan-denominated bonds issued in the Chinese mainland market by an overseas entity. 
  • International Finance Corporation (IFC) and Asian Development Bank (ADB) issued Panda Bonds in 2005.
• Uridashi Masala Bonds: Special type of Masala Bonds issued in Japan bought by Japanese retail investors.
• Bharat Bond ETF
  • Debt-based ETF made by pooling bonds issued by Central Public Sector Enterprises.
  • First corporate bond ETF of India.
  • It will invest in AAA-rated PSE bonds.
  • Minimum investment: `1000
  • Maximum Investment: for retail investors: `2 Lakh; Maturity Period: 3 year and 10 year

• Debentures: A type of debt instrument that is not secured by physical assets or collateral, backed only by the general creditworthiness and reputation of the issuer.
• Convertible: Bonds that can convert into equity shares of the issuing corporation after a specific period of time. 
• Non-Convertible: Regular debentures that cannot be converted into equity of the issuing corporation.

• Shares/Equity:  Shares represent units of ownership in a corporation or financial asset owned by investors who exchange capital in return for these units. 
• Stock: the capital raised by a corporation through the sale of shares.
• Derivatives: A financial security with a value that is derived from, an underlying asset or group of assets;
  • Common underlying assets: stocks, bonds, commodities, currencies, interest rates and market indexes. 
  • It can either be traded Over-The-Counter (OTC) or on an exchange.

• Swaps:  Often used to swap one kind of cash flow with another.
• Options: The buyer is not obligated to exercise the option, while the option seller is obligated to either buy or sell the underlying asset if the buyer chooses to exercise the contract. 
  • Types: Call Option (gives the holder the right to buy a stock) and Put Option (gives the holder the right to sell a stock.
• Warrant: Longer dated options (>1 year).
• LEAPS: Long-Term Equity Anticipation Securities. 
  • These are options having a maturity of up to three years.

Indian Capital Market

• Merchant Banks: Manages and underwrites new issues, provides consultancy and corporate advisory services for raising funds and other financial aspects.
• Hedge Funds: Financial partnerships that use pooled funds and employ different strategies to earn active returns for their investors.
• Mutual Funds : A type of financial vehicle made up of a pool of money collected from many investors to invest in securities – stocks, bonds, money market instruments, and other assets; Regulated by SEBI. 
  • Types of Mutual Funds
    • Open Ended Fund: These funds buy and sell units on a continuous basis and, hence, allow investors to enter and exit as per their convenience.
    • Close-Ended Funds: usually issue units to investors only once, when they launch an offer, called New Fund Offer.
    • Exchange-Traded Funds (ETFs): ETFs are a mix of open-ended and close-ended schemes.
• Venture Capital: A type of private equity, a form of financing that is provided by firms or funds to small, early-stage, emerging firms that are deemed to have high growth potential, or which have demonstrated high growth.
• Angel Investors: An affluent individual who provides capital for a business start-up usually in exchange for convertible debt or ownership of equity.
• Collective Investment Schemes (CIS): An arrangement which pools funds from investors to pool their money for investment in particular assets ; 
  • Regulated by SEBI.
• Social Venture Fund: National Innovation Council and the Ministry of MSME, launched the India Inclusive Innovation Fund (IIIF), an impact investment fund that will invest in ventures catering to the country’s poor. 
  • 500-crore fund, registered under market regulator SEBI’s Alternative Investment Fund regulations as a Category –I venture capital fund.
• Alternative Investment Fund: AIFs as any privately pooled investment fund, (whether from Indian or foreign sources), in the form of a trust or a company or a body corporate or a Limited Liability Partnership (LLP). AIF are classified as under by SEBI:
  • Category I: Which invests in areas Govt. considers economically and socially viable like Venture capital funds (Including Angel Funds), Social Venture Funds, Infrastructure funds. SEBI norms are lighter.
  • Category II: Private equity funds or debt funds. 
  • Category III: AIF such as hedge funds or funds which trade with a view to make short term returns and take excessive risk. SEBI norms are much stricter.
• Participatory Notes (P-Note): Instruments used by foreign investors not registered as FPIs to invest in the Indian stock market; 
  • Not issued in India rather these are issued by FPI registered in India to foreign investors; 
  • Due to the anonymity of the investor, FPIs are considered unsafe.
• Sovereign Wealth Fund: Fund set up by the government to invest its forex surplus in financial instruments like bonds, stocks, gold, etc.
• National Infrastructure And Investment Fund (NIIF)
  • Only sovereign wealth fund set up by India.
  • 49% is owned by the Indian Government and the remaining is owned by domestic and foreign investors. 
  • It is primarily set up to support infrastructure financing.

ESG (Environment, Social and Governance) Funds

• Kind of mutual fund. Its investing is used synonymously with sustainable investing or socially responsible investing. 
• While selecting a stock for investment, the ESG fund shortlists companies that score high on environment, social responsibility and corporate governance, and then looks into financial factors. 
• Regulated by: Securities and Exchange Board of India (SEBI).
• Launched by State Bank of India – SBI Magnum Equity ESG Fund.
• VIX Index: It has a strong negative correlation with Nifty; NSE measures the degree of volatility in the Nifty over the next 30 days through VIX Index. 

State Development Loans

• State Governments also raise loans from the market which are called SDLs. 
• SDLs are dated securities.
• Interest is serviced at half-yearly intervals and the principal is repaid on the maturity date. SDLs issued by the State Governments also qualify for SLR. 
• They are also eligible as collaterals for borrowing through market repo as well as borrowing by eligible entities from the RBI under the LAF. 

Exchange Traded Funds

• Fund that is created by pooling together assets and then dividing this accumulated asset into individual units that are traded on the stock exchange.
• The value of the ETF comes from the value of the underlying assets- shares of stock, bond, gold, etc.
• ETFs are a mix of open-ended and close-ended schemes.

Stock Exchange

• A physically existing institutionalized set-up where instruments of security stock market (shares, bonds, debentures, securities, etc.) are traded. Example: . BSE, NSE.

Investment Funds

Conclusion

• Capital markets are essential for facilitating long-term financing and investment in an economy. They are broadly categorized into primary and secondary markets.
• The primary market is where new securities are issued and sold to investors, while the secondary market enables the trading of previously issued securities among investors. 
• These markets provide avenues for businesses to raise capital for growth and for investors to participate in wealth creation and wealth transfer. 

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