Capital Markets
It is a platform for buyers and sellers of savings and investment instruments to come together
What Are Capital Markets?
Capital markets are like a marketplace where people who want to invest or save their money (called suppliers) meet those who need funds, such as companies and governments. It's where financial instruments like stocks and bonds are bought and sold.
In this market, there are two main groups: the suppliers (investors and banks) and those seeking funds (companies, governments, and the public). The capital market is divided into two parts; the primary market (where new securities are issued) and the secondary market (where existing securities are traded).
The goal of a capital market is to efficiently gather money for long-term investments and make it easier for people to trade financial assets. This market also encourages the ownership of various useful financial assets, lowering transaction and information costs.
The two most well-known markets within capital markets are the stock market and the bond market. They exist to bring together buyers and sellers, creating a platform for trading securities.
Most of the transactions in the capital market involve long-term securities. Importantly, the size of a country's capital markets is closely linked to its economy. This means that changes in the capital market can have a great effect on various sectors of the economy.
Key Takeaways
- Capital Market is a platform for buyers and sellers of investment instruments, capital markets bring together investors, companies, and governments seeking funding. It includes primary and secondary markets, enabling the trading of financial securities.
- Capital Market encompasses various financial assets, including stocks and bonds. Bonds offer periodic coupon payments and return face value at maturity, while stocks provide dividends and capital gains.
- Capital Market facilitates investment, enhances market access, promotes economic development, provides liquidity, determines asset prices, and offers diverse investment options to cater to different risk levels.
- Participants include investors, intermediaries (e.g., brokers, financiers), regulatory bodies like the SEC and FINRA, and organizations like the Federal Reserve Board, impacting capital, liquidity, and credit conditions in the market.
Capital Markets Types
There are two types of markets:
- The primary market, and
- Secondary market.
The primary market helps with capital formation, whereas the secondary market increases market liquidity. Together, they make up the capital market and enable its smooth operation.
1. Primary market
Corporations that raise cash by selling new shares through initial public offerings (IPO) make up the primary market. In addition, companies, governments, and public-sector organizations can raise money by selling bonds in this market.
Therefore, investors buy shares directly from a corporation in a primary market. In addition, new issuance of stocks and other securities are traded on primary markets.
In addition to IPOs, the primary market also sees the issuance of rights issues, private placement shares, and e-IPOs.
A corporation looks to its current investors when it needs to raise money from the market. Existing shareholders are given the option or privilege to purchase additional shares from the corporation, typically at a discounted price. It is a quick and effective way to raise money on the market.
Due to hefty incidental charges, some other businesses place company shares with selected private investors instead of through the IPO route. However, the primary market is also where these activities happen.
The primary market helps with capital formation, whereas the secondary market increases market liquidity. Together, they make up this market and enable its smooth operation.
2. Secondary Market
In the secondary market, anybody can buy and sell financial and investment products, including stocks, shares, and bonds. The primary function of a secondary market is the trading and exchanging existing or previously issued securities. Secondary markets include stock exchanges like the S&P 500 and NASDAQ.
One of the many benefits of secondary markets is the acceleration of capital formation, mobilization of savings, long-term capital development, promotion of industrial and economic growth, dynamic channeling of funds, and well-boosted generation of foreign capital.
The existence of the secondary market encourages people to invest through profitable channels, which in turn promotes the growth of the economy and industry. In addition to the categories mentioned above, a capital market, in the broadest meaning, refers to a market for any financial asset.
Capital Vs Stock Market
The stock market is a component of the capital market, and both have the same function of offering a way for a company to raise money for its operations. This market also issues debt securities like bonds and debentures in addition to stocks.
Contrarily, the stock market, commonly referred to as the equity market, is only for trading shares. Moreover, the financial characteristics of securities sold on a capital market, such as bonds, differ from those of stocks in that coupon payment. For example, the bond's face value must be repaid at maturity.
As for the stock, since it is an equity investment, the company will hold onto the money once it has been issued. As a result, investors will receive dividends and capital increases due to the stock's increase in value during the holding period, which can then be sold for a higher price.
Financial experts have also described the contrast between these two markets as a rectangle and a square. The two shapes are not the same despite having four sides and being joined at 90-degree angles.
While not all rectangles are square, all squares relate to the rectangle group. As with the stock market, capital includes more than just the stock market. Capital markets may handle all stock market transactions, but not all capital market transactions may take place in the stock market.
Example Of Assets You Can Invest In
For every investment type, there is an instrument that this market has to offer that investors can use to support. The most popular financial instruments are bond, stock, money, and derivatives markets.
A bond Market that focuses on raising money via the issuance of debt securities like bonds. Corporations or governments typically issue bonds to finance initiatives like building dams, roads, or bridges, purchasing equipment, etc.
A stock market is a regulated setting where investors can purchase or sell shares of a company's securities through brokers or dealers who operate as middlemen.
Due to the liquidity of money markets, firms and businesses can obtain short-term loans (less than a year) at rates lower than those banks pay for long-term loans.
Capital Markets Functions
It has many functions, such as increasing the efficiency and productivity of capital utilization and the country's income. It also promotes economic expansion and makes the trading of securities easier. Other functions are explained in detail in the following points.
1. Investment
In this market, there are two groups of people investors and debtors.
- Investors don't need money immediately, so they invest in the market for a longer time. This market makes investing and employing extra money possible rather than letting it sit around. For investors, rather than having cash sitting in bank accounts, they invest and gain some interest in their capital.
- Debtors who need money immediately for business could be for many reasons. As a result, the market allows businesses to borrow money from investors to invest in new machinery or other capital equipment.
In return, the company gains access to more efficient equipment, and the investor receives a dividend. This capital market position takes a macroeconomic approach to analysis.
2. Easy access to market
Investors now frequently trade on mobile devices, making financial markets more accessible than ever. Almost anybody can now access financial markets because of the advancement of technology.
Investors are ready to invest when they open an account with a broker. People can exit the market just as rapidly as they joined due to increased asset demand, creating liquidity.
3. Economic Development
Theis market encourages a marketplace for buyers and sellers, resulting in a more efficient transfer of funds. Corporate loan applicants can apply, and an underwriter will approve the loan.
It can also raise cash by selling a portion of its company on the stock market. This encourages economic growth since idle capital is used elsewhere in the economy. In other words, it raises demand. Businesses that need financing can grow if it is given to them.
The company that invested in the capital equipment offers it in exchange for cash. The circulation of that money will then allow the economy to keep expanding.
4. Liquidity
Because of the capital markets, people with money can invest it. In return, they are given ownership of a bond or stock. However, it might be necessary to liquidate them because they cannot utilize a bond certificate to buy a car, food, or other assets.
Selling assets to a third party on this market in exchange for liquid funds is a reasonably straightforward process for investors. If one chooses to sell an item at the current market price, there is almost always a buyer, allowing you to turn the asset into real money.
5. Price
One of the main goals of this market is to ensure that the underlying asset's price is accurate. A share's price may increase following good news or decrease following bad corporate results or some black swan event.
Because of the traders and the demand-supply, they create prices that fluctuate to the point where the equity value is reflected in the price. Bond prices can adjust even more quickly because bonds are viewed as a safer investment during a recession, and investors frequently prefer them.
6. Offers variety to Investors
This market provides a good variety of financial products to meet investors' needs, whether they want high or low levels of risk. It also gives investors the possibility to boost their return on investment.
Savings accounts pay very little interest, especially compared to the return on most equities. As a result, even with some danger, this market allows investors to earn a higher return rate than other financial instruments.
The Capital Markets Broad Constituents
Companies that raise money from domestic and international public and private sources are known as fundraisers.
The sources listed below assist businesses in raising money.
1. Investors
Entities that invest in this market are known as equity investors. These can be divided into institutional and retail investors and domestic and overseas investors. They invest in the market through various means, whether direct buying, mutual funds, or other such funds.
The list of investors who purchase securities on the secondary market are traders, speculators, FIIs/sub-accounts, mutual funds, venture capital funds, investors in ADRs and GDRs, and more.
2. Middlemen
Stockbrokers, sub-brokers, financiers, merchant bankers, underwriters, depository participants, registrars, transfer agents, FIIs/sub-accounts, mutual funds, venture capital funds, portfolio managers, custodians, etc., are examples of market service providers known as intermediary.
3. Entities
Broker-Dealers, Clearing Agencies, Credit Rating Agencies, Investment Banks, ATSs, Securities Exchanges, Transfer Agents, Self-Regulatory Organizations, and Stock Exchanges are only examples of different types of organizations.
4. Regulators in the U.S.
Numerous agencies oversee the U.S. stock market. The Securities and Exchange Commission is the main regulator. In addition, the Securities and Exchange Commission (SEC) is in charge of the stock exchanges, managed by their respective organizations.
A trade group that advocates for securities dealers are the Financial Industry Regulatory Authority (FINRA), formerly the National Association of Securities Dealers (NASD). It is responsible for regulating stockbrokers and brokerage firms.
Undoubtedly, one of the most well-known regulatory bodies in the world is the Federal Reserve Board (FRB). As a result, the "Fed" is criticized for contributing to the economic crisis or applauded for supporting it. Nevertheless, it generally impacts capital, liquidity, and credit conditions.
Its main tools for carrying out monetary policy are its open market activities, which regulate the buying and selling of U.S. Treasury and federal agency assets.
The number of reserves on hand or the federal funds rate at which depository institutions lend overnight balances to other depository institutions.
For instance, it may change due to purchases and sales. The banking industry is also subject to oversight and regulation by the Banking Industry Oversight and Regulation Board.
Capital Markets FAQs
The mismatch between supply and demand, which causes an increase or drop in stock price, is one of the significant factors influencing the market.
In addition, interest rates, political considerations, natural disasters, and inflation are additional factors that could impact the financial markets.
Equity shares of various publicly traded corporations are traded on the stock market. The markets also deal in other financial instruments like VIX futures, stock futures, stock options, index futures, and index options.
In stock markets, both equities and derivative items are traded.
The most common way businesses raise cash nowadays is through a public offering.
Information on stocks can be found in various places, including newspapers, websites, corporate annual reports, etc. On their websites, brokerage firms also offer a wealth of insightful stock market analytics.
Typically, the company's profitability and growth potential determine the stock price. The market often assigns a P/E ratio based on a company's desirable characteristics. In addition to supply and demand, news flow also affects stock prices.
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