Capital Market

“Risk comes from not knowing what you're doing.”
-Warren Buffet (Business Magnate, Investor, Philanthropist)

Financial Markets can be understood as the marketplace where the trading of financial instruments takes place, which can be broadly divided as shown below:

Capital Markets deals with financial instruments, primarily in equities, that have no finite maturity, which are more risky on the short-term and less risky on the long-term.

Commodity Markets deals with instruments that trade in commodities, such as Crude, Gold etc.,

Currency Markets deals with instruments that trade in currencies. Markets in India deal in USD-INR, YEN-INR, GBP-INR and EUR-INR.

Real Estate Funds, are similar to Mutual Funds and primarily trade in Real-Estate Investment Trusts (REITs), which have a long-term maturity period, which are less liquid, and give higher returns over a period of time.

Debt Markets deal with financial instruments that have both short and long maturity periods, which offer lesser returns and are considered far less risky.

The various Market Instruments may be traded either on Spot Market or in Derivatives Markets. This Chapter covers how Capital Market Instruments are traded on spot. To know about Derivatives Market, CLICK HERE.

Now let’s get to know which market your money should be invested in.

Traditional tools like Fixed Deposits, Real Estate, Gold etc. may however serve your purpose, but on the long run it is always smarter to invest in financial instruments available in the market. This is simply true based on the fact that funds invested in financial markets yield higher levels of Wealth creation. Let’s see why below:

a.Capital Market Offers Higher Returns: The returns received on financial instruments with Banks are fixed, while those on Equity is based on Market Performance and have always proven to provide superior returns.

b.Capital Market Beats Inflation: To understand this, we need to run through two concepts; what inflation is and how capital market instruments keep up with it. Inflation is basically the increase in prices with a corresponding decrease in the purchasing value of money. It can occur due to a number of reasons such as increase in demand of products/services, rise in cost of production or higher supply of money in the economy. As such, every person in the economy is affected by inflation too. The Capital Market not just keeps up with inflation, it beats Inflation on the long run.

c.Capital Market offers Tax Benefits: Investing in Capital Market can be extremely beneficial, as Long-Term Capital Gains are exempt from being taxed.

d.Capital Markets give you Ownership: Apart from investing and receiving returns and capital gains, buying the stock of a company in the capital market makes you one among the owners of the company, giving you the power to vote on the decisions of the company.

e.Capital Market is built for Investors: With Securities and Exchange Board of India (SEBI) as the custodian of the Capital Market, investors are protected from any or all malpractices and fraud, ensuring the safety of investor money.

Let’s get into Historical Facts to see which makes more money, the following table helps understand the difference between investing in Fixed Deposits and Capital Market:

The table compares data between investments made in Fixed Deposit and in Equities over the period between 1999 to 2016. An investment of One Lakh Rupees (INR 1,00,000) is made in Fixed Deposit with a Bank and in the Equity Capital Market every year. The data uses FD rates as per RBI and Nifty Average Price as per NSE. The data shows that a total investment of Eighteen Lakh Rupees (INR 18,00,000) appreciates to Rs.41,16,762/- in FD, whereas it appreciates to Rs.81,05,489/- in Equities which is almost twice the FD end value. Fixed deposits are subject to Tax, whereas since the investment in Equity is over one year, the returns are considered as Long Term Capital Gain, and thus not taxable.

Now that we are clear on which market to invest in, let’s get to know what are the various options available in the Capital Market for Wealth Creation.

Capital markets facilitate the trade or exchange in securities which generally have medium or long term durations.

Let’s have a look at what Equity and Debt Instruments are. Other capital Market instruments have been covered under the respective heads on our Education page.

Equity Securities (also called Stock/Share) are securities that indicate ownership interest in the company, and thus Equity refers to the funds raised by the company by issuing stock or shares.

Debt Securities are securities which are offered by the company to the investor in order to raise funds in the form of Debt, and thus Debt refers to the funds raised by a company which are to be repaid in full along with interest

Signifies Ownership as a Shareholder Secured Creditor of the Company
Risk Comparatively Higher Comparatively Lower
Returns Level Relatively Higher Relatively Lower
Returns Rate Not Fixed Fixed Rate

Apart from the type of securities dealt in it, Capital Market include broadly two type of markets within it, namely the Primary Market, where new securities are issued and Secondary Market, where existing securities are traded.

Knowledge of these instruments alone won’t create wealth, let’s get to know how to make smart investments in the Capital Market.

“Capital Markets are risky”, “Equities are uncertain investments”, “Money in Markets are never safe”; If you have heard this or something related to it at some point, you heard right but the risk, uncertainty and insecurity comes with lack of Knowledge, Research & Understanding. Knowing how to invest in Capital Markets comes with In-depth Research and Understanding how the market operates, its fluctuations and the reasons behind it.

The primary objective for any person participating in Capital market is to identify themselves as a Fresher, an Investor or a Trader. Depending on your position in the market, what to buy/sell – how to buy/sell – why to buy/sell, are effected too. Ideally,

  • A Fresher in the Capital Market shall mainly involve themselves in Large-Cap Mutual Funds, Exchange Traded Funds with an expert Mutual Fund House which comparatively have lesser risk;
  • An Investor shall look into investing in market opportunities that are focused on medium and long term returns; and
  • A trader mainly partakes in capitalizing in regular market opportunities which have higher risk and higher returns.

Depending on the position you have in the market, the kind of analysis you need to undertake also differs. It takes a considerable amount of time to reach a state where it becomes easier to operate in the Capital Market, but for investors in the market must focus on certain key attributes to be analyzed, which can be broadly divided into Fundamental Analysis and Technical Analysis.

An Investor should chiefly focus on Fundamental Analysis and then Technical Analysis. Whereas a trader would primarily need to look into Technical analysis and then Fundamental Analysis.

Let’s understand Capital Market Analysis Better:

a.Fundamental Analysis 

The objective of fundamental analysis is to find the worth of a Company by inspecting the Company’s financials, understanding how the company is currently performing in its industry by assessing its financial attributes, along with certain micro and macro-economic factors.

The Analysis of a Company’s financials necessarily must include:

  Sales – One of the important factor to analyze a company’s performance is its sales. A growing company keeping up with latest trends, technology, product mix and such other like factors, is bound to have a growing Sales rate.

  Profits Made – A company reporting a growing sales rate should normally report higher growth in profits and dividends at a higher rate every year. Dividends received by a shareholder is paid out of the Profits of the Company. (Note: Companies may opt not to pay dividends depending on Company Policy; but the analysis tends to achieve the conjecture)

  Profits Margin – This determines what part of the total sales the company retains with itself as its earnings. It is expressed as a percentage. For instance, if the company makes INR One Lakh (Rs. 1,00,000/-) in Sales, having a profit margin of 20%, then the company earns a net income of INR Twenty Thousand (Rs. 20,000/-). Constantly rising Profit Margins suggests how well the company is run by the Management, its leadership efficiency in decision making and such like factors. There are two types of profit margins, namely:

i.Net Profit Margin: which shows how much revenue is left after all expenses have been deducted from sales (NPM=Net Income/Net Sales); and

ii.Operating Profit Margin: which shows how much revenue is left after operating expenses have been paid and what proportion of revenue is left to cover non-operating costs. (OPM=Operating Income/Revenue)

  Debt-Equity Ratio – This ratio represents the ratio between the amount of debt the company uses to finance its assets and the amount of value represented in shareholders’ equity. The lower the ratio, the better the company is doing its business. With a higher debt-equity ratio, the company has an obligation to pay higher debts, making the company prone to a greater liability.

  Market Share – Market share represent the percentage of the market’s total sales earned by the company. A company having a higher and a growing rate of market share represents an apt growth in the number of customers serviced by the company, which signifies that the Company is well perceived by the customers in the market and is likely to remain so.

Now that you have understood how to analyze the financials of a company, let’s dig deeper. Apart from the financials, certain Micro & Macro-economic factors also determine the performance of the company. They include:

Micro-Economic Factors are factors that position the Company in its relevant market. It includes the following elements:

  Stakeholder Relations; refers to the effectiveness of the Company in maintaining a stable relationship with all its stakeholders namely, Customers, Employees, Shareholders (owners)- the dividend, bonus etc. given, Creditors and the like.

  Market Position; refers to the position of the Company in the market with respect to its competitors in terms of Product Mix, Technology devised in operations, market capitalization, customer base and the like. Companies performing well have an excellent product mix for their customers, keeping up with current and future needs using state-of-the-art technology

 Macro-Economic Factors are factors that affect the position of the Company due to the presence of external forces. It includes the following elements:

  Government & Legal Policies; refers to the policies introduced which have a bearing on the working of the company. This may include Tax Policies, Annual Financial Budget, Statutory implications and the like.

  RBI Rates: refers to the Repo & Reverse Repo Rates of the RBI. This affects the borrowing capacity of the Company. With a lower Repo Rate, Companies can borrow funds at a lower interest rate, and thus reducing their debt risk.

  Market Indicators; refers to various growth indicators in the market which enable an investor to determine the company’s position in the industry and economy. These include:

(i)Gross Domestic Product (GDP) – monetary value of all goods and services produced over a period of time;

(i)Index of Industrial Production (IIP) – index of growth of various sectors in the economy;

(i)Inflation – rise in prices of goods and services and subsequent fall in purchasing power of currency

These indicators depict how the economy of the country is in general and which sectors are preferable to invest.

With that, you have completed how to carry out the fundamental analysis of a company. This would ideally help you choose the companies to invest in. But that alone won’t help you operate in the market. You also need to know when to buy and when to sell these stocks too. So let’s get ahead with Technical Analysis.

a.Technical Analysis 

The objective of technical analysis is to use market data to identify market trends and predict future prices, which helps to determine whether it is ideal to Buy, Sell or Hold a particular stock. It involves understanding the movement of stocks in the market through various technical analysis tools. However, neither is technical analysis a foolproof hack into the market, nor is it 100% accurate. It rather provides a better understanding and insight as to which stock is likely to perform better in the market in future. Technical Analysis Tools Include:

  Share Price & Volume – Analyzing the share price and volume charts of the Company is an important element of Technical Analysis. This includes the liquidity volume of the share and such other factors like Price Data Analysis over a particular timeframe.

  Trend Analysis - Analyzing trends and patterns from various technical charts and graphs to determine the position of the stock in the market.

  Technical Indicators – Using tools such as trend-lines, moving averages and momentum indicators to forecast stock price movement in the market.

Gains/Losses from Equity Trading are obligated to go through the books of accounts of the trader for tax purposes. Trading in Equity is taxed based on the period of time which the security is held. They may be understood as:

Short-Term Capital Gain/Loss; where the gain/loss has been effected in a period less than a year (buying a stock & selling it within a year); and

Long-Term Capital Gain/Loss; where the gain/loss has been effected in a period more than a year (buying & holding a stock beyond a year, and then selling it).

Short-Term Capital Gains are to be taxed as per Income tax slab of the trader, while Long-Term Capital Gains are exempt from being taxed. However, both Short-Term and Long-Term Capital Losses may be set off against any Short-Term or Long-Term Capital Gains from being taxed.

However, in India, there exists a levy of Securities Transaction Tax (STT). STT is levied on all trades, and the rates vary depending on the type of securities. STT is a direct tax levied by the Central Government of India. Let’s have a look at the current STT rates applicable:

Type of Transaction STT Rate Payable By
Purchase of Equity Share in a Company 0.100% Purchaser; on the value of taxable securities transaction based on the volume weighted average price.
Sale of Equity Share in a Company 0.100% Seller; on the value of taxable securities transaction based on the volume weighted average price.
Sale of Equity Share in a Company, Settled otherwise than by actual delivery/transfer of share 0.025% Seller; on the value of taxable securities transaction based on the volume weighted average price.

Important Notice: "Prevent Unauthorised transactions in your Trading /demat account --> Update your mobile numbers/email IDs with your stock brokers / Depository participants. Receive information/alerts of your all debits and other important transactions directly from Exchange /Depository on your mobile/email at the end of the day .......... Issued in the interest of investors"                           KYC is one time exercise while dealing in securities markets - once KYC is done through a SEBI registered intermediary (broker, DP, Mutual Fund etc.), you need not undergo the same process again when you approach another intermediary."                          “No need to issue cheques by investors while subscribing to IPO. Just write the bank account number and sign in the application form to authorise your bank to make payment in case of allotment. No worries for refund as the money remains in investor’s account.”