Capital Market: Functions, Need, Evolution and growth (in pre-independence era)

Introduction
The Capital Market is a market for financial investments that are direct or indirect claims to
capital. It embraces all forms of lending and borrowing, whether or not evidenced by the
creation of a negotiable financial instrument. The Capital Market comprises the complex of
institutions and mechanisms through which intermediate term funds and long term funds are
pooled and made available to business, government and individuals. The Capital Market also
encompasses the process by which securities already outstanding are transferred.
The capital market and in particular the stock exchange is referred to as the barometer of the
economy. Government’s policy is so moulded that creation of wealth through products and
services is facilitated and 4 EP-CM&SL surpluses and profits are channelized into productive
uses through capital market operations. Reasonable opportunities and protection are afforded
by the Government through special measures in the capital market to get new investments
from the public and the Institutions and to ensure their liquidity

Evolution
The history of capital market in India dates back to almost 200 years. Indian stock markets
are one of the oldest in Asia. In the early nineteenth century, there are some signs of
existence of capital market in India. Though the records are meagre, there are some evidences
of presence of capital market during the first half of the nineteenth century
But the evolution of modern Indian Capital market is can be divided into four important
phases
The first phase is from the inception of the capital markets in India upto the First World War
i.e.1875-1919. This phase brings out initial development in the capital market in India. This
studies the inception of the capital market, limitations for the development at the early stage
and the emergence of various stock exchanges in India. This period also coincides with end
of American Civil War. The brokers who had no place to trade came to Mumbai to negotiate
on a piece of paper which later took the form of share certificate. The place where the brokers
assembled and transacted business regularly, is now known as Dalal Street and the building
which is popularly reckoned as a premier stock exchange, is now known as ‘Jijibhoy
Towers’. In 1887, these brokers formally established the ‘Native Share and Stock Exchange
Association’. However, in 1895, the stock exchange acquired a premise in the same street and
it was formally inaugurated in 1899. Thus, the stock exchange of Mumbai (now called as
BSE) came into existence. Apart from Mumbai, Ahmedabad, Calcutta also gained importance
because of its textile production and jute production respective thus in 1894, the brokers
formed the ‘Ahmedabad Share and Stock Brokers Association’ and 1908 the “Calcutta Stock
Exchange Association” was formed
The second phase starts from 1920 i.e. the period when industrial revolution had spread over
a large part of globe, but India, under British Empire, remained underdeveloped country. The
phase is restricted upto 1947 when India got independence. It also highlights the glimpses of
development during the volatile period for the market as well as Indian polity. This period
marks rise of stock market activity in South India. In 1937 Madras Stock Exchange
Association Pvt. Ltd was instituted. The period also saw initial boom and later fall on account
of the Second World War. Around this time, some more stock exchanges which came into
existence were- the Uttar Pradesh Stock Exchange Limited (1940), Nagpur Stock Exchange
Limited (1940) and Hyderabad Stock Exchange Limited (1944). In Delhi, around this time
two separate stock exchanges were formed viz. ‘Delhi Stock and Share Broker’s Association
Limited’ and the ‘Delhi Stock and Share Exchange Limited’. During the World War II, these
two exchanges were floated
The third phase starts with 1947 i.e. independence and it is upto 1990 i.e. announcement of
the New Economic Policy. This was the period when the capital market in India has shown
development in real sense. Quantitatively as well as qualitatively, there was a remarkable
development in capital market during this phase.
The first act to regulate and recognize the exchanges came into force in 1956 i.e. Securities
Contracts (Regulation) Act, 1956. The established stock exchanges of Mumbai, Ahmedabad,
Calcutta, Madras, Delhi, Hyderabad and Indore were recognized under the act
The final phase starts from 1991 to the present date. Especially after the adoption of
Liberalization - Privatization - Globalization (LPG) policy, there is huge attention of the
global financial markets on Indian capital market. The uses of technology, variety of
products, investor protection are the areas which emerged during the last two decades. Even
though there was quantitative increase in the Indian capital market; there were some inherent
limitations like lack of liquidity, imperfections in the information, lack of transparency, long
settlement periods etc.

Need
 Capital market plays an extremely important role in promoting and sustaining the
growth of an economy
 It is an important and efficient conduit to channel and mobilize funds to enterprises,
both private and government.
 It provides an effective source of investment in the economy.
 It plays a critical role in mobilizing savings for investment in productive assets, with a
view to enhancing a country’s long-term growth prospects, and thus acts as a major
catalyst in transforming the economy into a more efficient, innovative and
competitive marketplace within the global arena.
 capital markets also provide a medium for risk management by allowing the
diversification of risk in the economy
 A well-functioning capital market tends to improve information quality as it plays a
major role in encouraging the adoption of stronger corporate governance principles,
thus supporting a trading environment, which is founded on integrity.
 Capital market has played a crucial role in supporting periods of technological
progress and economic development throughout history
 Liquid markets make it possible to obtain financing for capital-intensive projects with
long gestation periods.
  Capital markets make it possible for companies to give shares to their employees via
ESOPs
 Capital markets provide a currency for acquisitions via share swaps.
 Capital markets provide an excellent route for disinvestments to take place.
 Venture Capital and Private Equity funds investing in unlisted companies get an exit
option when the company gets listed on the capital markets
 The existence of deep and broad capital market is absolutely crucial in spurring the
growth our country. An essential imperative for India has been to develop its capital
market to provide alternative sources of funding for companies and in doing so,
achieve more effective mobilisation of investors’ savings. Capital market also
provides a valuable source of external finance.

For a long time, the Indian market was considered too small to warrant much attention.
However, this view has changed rapidly as vast amounts of both international and domestic
investment have poured into our markets over the last decade. The Indian market is no longer
viewed as a static universe but as a constantly evolving one providing attractive opportunities
to the investing community.

Functions of the Capital Market

While from a broader perspective, capital markets are viewed as a market of

financial assets with long or infinite maturity, it actually plays a very important role in
mobilising resources and allocating them to productive channels. So it can be said
that the process of economic growth of a country is facilitated by the capital markets.
The important functions and significance of the markets have been discussed below:

1. Economic Growth: The capital markets help to accelerate the process of

economic growth. It reflects the general condition of the economy. Capital
market helps in the proper allocation of resources from the people who have
surplus capital to the people who are in need of capital. So, we can say that it
helps in the expansion of industry and trade of both public and private sectors
leading to a balanced economic growth in the country.
2. Promotes Saving Habits: After the development of capital markets, the
taxation system and the banking institutions provide facilities and provisions to
the investors to save more. In the absence of capital markets, they might have
invested in unproductive assets like land or gold or might have indulged in
unnecessary spending.
3. Stable and Systematic Security prices: Apart from mobilisation of funds,
the capital markets helps to stabilise the prices of stocks. Reduction in the
speculative activities and providing capital to borrowers at a lower interest rate
help in the stabilisation of the security prices.
 4. Availability of Funds: Investments are made in capital markets on a
continuous basis. Both the buyers and sellers interact and trade their capital
and assets through an online platform. Stock Exchanges like NSE and BSE
provide the platform for this and thus the transactions in the capital market
become easy.
5. Link between Savers and Investors: The capital market functions as a link
between savers and investors. It plays an important role in mobilising the
savings and diverting them in productive investment. In this way, capital
market plays a vital role in transferring the financial resources from surplus
and wasteful areas to deficit and productive areas, thus increasing the
productivity and prosperity of the country.
6. Encouragement to Investment: The capital market facilitates lending to
the businessmen and the government and thus encourages investment. It
provides facilities through banks and nonbank financial institutions. Various
financial assets, e.g., shares, securities, bonds, etc., induce savers to lend to
the government or invest in industry. With the development of financial
institutions, capital becomes more mobile, interest rate falls and investment
increases.
7. Benefits to investor

The credit market helps the investors, i.e., those who have funds to invest in
long-term financial assets, in many ways:

a) It brings together the buyers and sellers of securities and thus ensure
the marketability of investments,
b) By advertising security prices, the Stock Exchange enables the
investors to keep track of their investments and channelize them into
most profitable lines,
c) It safeguards the interests of the investors by compensating them
from the Stock Exchange Compensating Fund in the event of fraud
and default.

Mutual funds: features, advantages, disadvantages

Introduction

A Mutual Fund is a trust that pools the savings of a number of investors

who share a common financial goal. The money thus collected is then
i n v e s t e d i n c a p i t a l market instruments such as shares, debentures and other
securities. The income earned through these investments and the capital
appreciation realized are shared by its unitholders in proportion to the number of units
owned by them. Thus a Mutual Fund is the most suitable investment for the common
man as it offers an opportunity to invest in a diversified, professionally managed basket of
securities at a relatively low cost.
The flow chart below describes broadly the working of a mutual fund:

A mutual fund is a financial intermediary that pools the savings of investors for collective
investment in a diversified portfolio of securities. A fund is “mutual” as all of its returns,
minus its expenses, are shared by the fund’s investors.

The Securities and Exchange Board of India (Mutual Funds) Regulations, 1996 defines a
mutual fund as a ‘a fund established in the form of a trust to raise money through the sale of
units to the public or a section of the public under one or more schemes for investing in
securities, including money market instruments’

According to the above definition, a mutual fund in India can raise resources through sale of
units to the public. It can be set up in the form of a Trust under the Indian Trust Act. The
definition has been further extended by allowing mutual funds to diversify their activities in
the following areas:

 Portfolio management services

 Management of offshore funds
 Providing advice to offshore funds
 Management of pension or provident funds
 Management of venture capital funds
 Management of money market funds
 Management of real estate funds

A mutual fund serves as a link between the investor and the securities market by mobilising
savings from the investors and investing them in the securities market to generate returns.
Thus, a mutual fund is akin to portfolio management services (PMS). Although, both are
conceptually same, they are different from each other. Portfolio management services are
offered to high net worth individuals; taking into account their risk profile, their investments
are managed separately. In the case of mutual funds, savings of small investors are pooled
under a scheme and the returns are distributed in the same proportion in which the
investments are made by the investors/unit-holders.

Mutual fund is a collective savings scheme. Mutual funds play an important role in
mobilising the savings of small investors and channelizing the same for productive ventures
in the Indian economy.
Mutual Funds Set Up In India
The structure of mutual fund operations in India envisages a three tier
establishment namely: (II) A Sponsor institution to promote the fund (III) A
team of Trustees to oversee the operations and to provide checks for the efficient,
profitable and transparent operations of the fund and (IV)
An Asset Management Company to actually
deal with the funds. Sponsoring Institution The Company which sets up the
Mutual Fund is call criteria to be met by the sponsor. These criteria mainly deal
with adequate experience, good past tract record, net worth etc.
Trustees: Trustees are people with long experience and good integrity in their
respective fields. They carry the crucial responsibility of safeguarding the interest
of investors. For this purpose, they monitor the operations of the different
schemes. They have wide ranging powers and they can even dismiss Asset
Management Companies with the approval of the SEBI.

Asset Management Company (AMC) The AMC actually manages the funds of
the various schemes. The AMC employs a large number of professionals to make
investments, carry out research and to do agent and investor servicing. Infact, the
success of any Mutual Fund depends upon the efficiency of this AMC. The AMC
submits a quarterly report on the functioning of the mutual fund to the trustees
who will guide and control the AMC.
Types of Mutual Funds
1 Close Ended Funds Close ended funds are funds which have definite period
or target amount. Once the period is over and or the target is reached, the door is
closed for the investors. They cannot purchase any more units. These units are
publicly traded through stock exchange and generally, there is no repurchase
facility by the fund. The main objective of this fund is capital appreciation. Thus
after the expiry of the fixed period, the entire corpus is disinvested and the
proceeds are distributed to the various unit holders in proportion to their holding.
Thus the fund ceases to be a fund, after the final distribution. E.g. UTI Master
Share, 1986.

2 Open Ended Funds Open ended funds are those which have no fixed maturity
periods. Open ended scheme consists of mutual funds which sell the units to the
public. These mutual funds can also repurchase the units. Initial Public Offer
(IPO) is open for a period of 30 days and then reopens as an open-ended scheme
after a period not exceeding 30 days from the date of closure of the IPO. Investors
can buy or repurchase units at net asset value or net value related prices, as
decided by the mutual fund. Example: Unit Trust of India‗s Growth sector funds.
Classification of Mutual Funds

On The Basis Of Yield and Investment

1. Income Fund Income funds are those which generate regular income to the
members on a periodical basis. It concentrates more on the distribution of regular
income and it also sees that the average return is higher than that of the income
from bank deposits. a. The investor is assured of regular income at periodical
intervals b. The main objective is to declare regular dividends and not capital
appreciation. c. The investment pattern is towards high and fixed income yielding
securities d. It is concerned with short run gains only.
2. Growth Fund Growth are those which concentrate mainly on long term gains
i.e., capital appreciation. Hence they are termed as “Nest investmentsEggs”. a. It
aims at meeting the investors need for capital appreciation. b. The investor‗s
strategy conforms to investing the funds on equities with high growth potential.
c. The Investment tries to get capital appreciation by taking much risks and
investing on risk bearing equities and high growth equity shares. d. The fund
declares dividends. e. It is best suited to salaried and business people.
3. Balanced Fund It is a balance between income and growth fund. This is called
as Income cum growth. It aims at distributing regular income as well as capital
appreciation. Thus the investments are made in high growth equity shares and
also the fixed income earning securities.

4. Specialized Funds These are special funds to meet specific needs of specific
categories of people like pensioners, widows etc.

Money Market Mutual Funds The funds are invested in money market
instruments. These funds basically have all the features of open ended funds but
they invest in highly liquid and safe securities like commercial paper, banker‘s
acceptances, and certificates of deposits treasury bills. These funds are called
money funds in the U.S.A. The RBI has fixed the minimum amount of investment
as Rs.1 Lakh; it is out of the reach of many small investors. However, the private
sector funds have been permitted to deal in money market mutual funds. It is best
suited to institutional investors like banks and other financial institutions.

6. Taxation Funds It is a fund which offers tax rebated to the investors either in
the domestic or foreign capital market. It is suitable to salaried people who want
to enjoy tax rebates particularly during the month of February and March. An
investor is entitled to get 20% rebated in Income Tax for investments made under
this fund subject to a maximum investment of Rs.10,000 per annum. E.g. Tax
Saving Magnum of SBI Capital Market Limited.

7. Other Classification

i. Leveraged Funds: Also called as borrowed funds as they are used primarily to
increase the size of the value of portfolio of a mutual fund. When the value
increases, the earning capacity of the fund also increases.

ii. Dual Funds: It is a fund which gives a single investment opportunity for two
different types of investors. It sells income shares and capital. Those investors
who seek current investment income can purchase incomes shares. The capital
shares receive all the capital gains earned on those shares and they are not entitled
to receive any dividend of any type.

iii. Index Fund: It is a fund based the some broad market index. This is done by
holding securities in the same proportion as the index itself. The value of these
index linked funds will automatically go up whenever the market index goes up
and vice versa.

iv. Bond Funds: The funds have portfolios consisting mainly of fixed income
securities like bonds. The main thrust is income rather than capital gains.
v. Aggressive Growth Funds: These funds are capital gains oriented and thus the
thrust area of these funds is capital gains. Hence, these funds are generally
invested in speculative stocks They may also use specialized investment
techniques like short term trading, option writing etc.,

vi. Off shore Mutual Funds: These funds are meant for nonresident investors.
These funds facilitate flow of funds across different countries, with free and
efficient movement of capital for investment and repatriation.

vii. Property Fund: These funds are real estate mutual funds. Its investment also
includes shares/bonds of companies involved in real estate and mortgage backed
companies.

viii. Fund of Funds: It is a fund that invests in other mutual fund schemes. The
concept in prevalent in abroad.

3 History of Mutual Funds In India

The Mutual fund concept in India was launched by Unit Trust of India (UTI) in
the year 1964 by a special Act of Parliament. The first scheme offered was the
―US-64. A host of other fund schemes were subsequently introduced by the UTI.
The basic objective behind the setting up of the Trust was to mobilize small
savings and to allow channeling of those savings into productive sectors of the
economy, so as to accelerate the industrial and economic development of the
country. In 1987, the Government of India permitted commercial banks in the
public sector to set up subsidiaries operating as trusts to perform the functions of
mutual funds by amending the Banking Regulation Act. SBI set its first mutual
fund, followed by Canara Bank. Later many large financial institutions under
government control also came out with mutual funds subsidiaries. Recently, with
the beginning of the economic reforms and liberalization of the economy, based
on the recommendations of the Abid Hussain committee, foreign companies were
also permitted to start mutual funds in India. The government introduced a
number of regulatory measures, through various agencies such as the SEBI, to
the benefit the investors, esp. the small investors.

Features
Portfolio Diversification/Risk Diversification
Most Mutual Funds invest in 50 to 100 different investments based on market
capitalisation, sectors and many other demographics.

Hence, Mutual Funds offer a diversified investment portfolio even with a small amount of
investment that would otherwise require big capital. Even with big capital, it is extremely
difficult and time-consuming to purchase and manage a wide range of investments
individually.

However, Mutual Funds reduce the risk of loss as the portfolio is largely diversified and
the purchases are backed by research and experience of the fund house. Moreover, the loss
is also shared with other investors in the same fund. This diversification of risk is one of
the key benefits of a collective investment instrument like mutual funds.

Professional Management
Mutual Fund schemes are managed by qualified experienced professionals who work
towards the fund's defined objective.

While, investors may differ in their investment needs based on their financial goals.
Therefore, mutual funds make the best way one can invest in Equities, Debt or
Commodities.

Affordability
A mutual fund invests generally buy and sell various asset classes in large volumes
allowing investors to benefit from lower trading costs. Investors can get exposure to such
portfolios with an investment as modest as Rs.500/- (Subject to requirements of the Asset
Management Company (AMC)) in mutual funds through a Systematic Investment Plan.
Such portfolio would otherwise be extremely expensive to purchase and maintain for an
investor investing directly in stock market.

Liquidity
With open ended funds, investors can redeem (encash) all or part of their investments at
prevailing net asset value, at any point of time. Mutual Funds are more liquid than most
investments in shares, deposits, and bonds. In addition, a standardised process enables
quick and efficient redemption allowing investors to get cash in hand as soon as possible.
For closed ended schemes, investors can redeem their investments at prevailing Net Asset
Value, subject to exit load at specific intervals, if provided in the scheme. In certain
schemes, where lock in period is mentioned, investor cannot redeem his investment until
that period.

Transparency
Mutual Funds are the most transparent form of investment. Investors receive detailed
information and timely updates about the nature of investments made, fund manager's
investment strategy behind the investments, the exact amount invested in each type of
security, etc. Moreover, the performance of a Mutual Fund is reviewed by various
publications and rating agencies, making it easy for investors to compare one fund to
another.

Rupee-cost Averaging
Rupee cost averaging or SIP provides the investor a disciplined approach of investing
specific amount at regular intervals regardless of the unit price of the investment. Therefore,
the money invested fetches more units when the price is low and lesser when the price is
high. Thus, allowing you to achieve a lower average cost per unit over time. The strategy
helps smoothen out market ups and downs in the long run, while reducing the risk of
investing in volatile markets.

Regulations
All Mutual Funds are required to register with Securities Exchange Board of India (SEBI).
With investor interest at the helm, SEBI has laid down strict regulations to safeguard
investors against possible frauds. It is even mandatory for Mutual Fund distributors to
register with Association of Mutual Funds in India (AMFI) and abide the norms laid by the
Securities and Exchange Board of India (SEBI) and AMFI for the distributors.

Choice of Investment
Mutual Funds are the only product category that caters to every one’s needs. You will
always find a mutual fund that matches your time horizon – long, medium, or short; and
your risk-taking ability – low, medium, high. All this irrelevant of how much you invest,
be it a very small investment or a huge Lumpsum. Your adviser will help choose the right
fund/s for you keeping in mind your profile.
Minimizing Costs
Mutual Funds help investors to benefit from economies of scale as mutual funds pool
money from vast number people with common interest and invest their money in the
relevant asset class/classes. This helps the investors share the cost of management of their
money.

Benefits of Mutual Funds

An investor can invest directly in individual securities or indirectly through a financial

intermediary. Globally, mutual funds have established themselves as the means of investment
for the retail investor.

1. Professional management: An average investor lacks the knowledge of capital

market operations and does not have large resources to reap the benefits of
investment. Hence, he requires the help of an expert. It, is not only expensive to ‘hire
the services’ of an expert but it is more difficult to identify a real expert. Mutual funds
are managed by professional managers who have the requisite skills and experience to
analyse the performance and prospects of companies. They make possible an
organised investment strategy, which is hardly possible for an individual investor.

2. Portfolio diversification: An investor undertakes risk if he invests all his funds in a

single scrip. Mutual funds invest in a number of companies across various industries
and sectors. This diversification reduces the riskiness of the investments.

3. Reduction in transaction costs: Compared to direct investing in the capital market,

investing through the funds is relatively less expensive as the benefit of economies of
scale is passed on to the investors

4. Liquidity: Often, investors cannot sell the securities held easily, while in case of
mutual funds, they can easily encash their investment by selling their units to the fund
if it is an open-ended scheme or selling them on a stock exchange if it is a close-ended
scheme

5. Convenience: Investing in mutual fund reduces paperwork, saves time and makes
investment easy.

6. Flexibility: Mutual funds offer a family of schemes, and investors have the option of
transferring their holdings from one scheme to the other.

7. Tax benefits: Mutual fund investors now enjoy income-tax benefits. Dividends
received from mutual funds’ debt schemes are tax exempt to the overall limit of Rs
9,000 allowed under section 80L of the Income Tax Act.
8. Transparency: Mutual funds transparently declare their portfolio every month. Thus
an investor knows where his/her money is being deployed and in case they are not
happy with the portfolio they can withdraw at a short notice.

9. Stability to the stock market: Mutual funds have a large amount of funds which
provide them economies of scale by which they can absorb any losses in the stock
market and continue investing in the stock market. In addition, mutual funds increase
liquidity in the money and capital market.

10. Equity research: Mutual funds can afford information and data required for
investments as they have large amount of funds and equity research teams available
with them.