Savings and investments are channelled through capital markets between suppliers and those in need. Banks and investors are examples of suppliers because they have the capital to lend or invest. Businesses, governments, and individuals are all looking for capital in this market. Primary and secondary markets comprise capital markets.
The stock and bond markets are the two most common capital markets. They aim to improve transactional efficiencies by bringing suppliers and those seeking capital together and providing a venue for them to exchange securities.
Understanding Capital Markets
Capital market refers to the in-person and digital spaces in which various entities trade various financial instruments. The stock market, bond market, and currency and foreign exchange (forex) markets are examples of such venues. The majority of markets are concentrated in major financial hubs like New York, London, Singapore, and Hong Kong.
Capital markets are made up of both fund suppliers and fund users. Households and institutions such as pension and retirement funds, life insurance companies, charitable foundations, and non-financial companies that generate excess cash are examples of suppliers. In addition, home and automobile buyers, non-financial companies, and governments financing infrastructure investment and operating expenses are among the recipients of capital market funds.
Capital markets primarily sell financial products such as stocks and bonds. Equities are stocks that represent ownership stakes in a company. Debt securities, such as bonds, are IOUs that pay interest.
Types of Capital Market
The capital market consists of two types i.e. Primary and Secondary.
- The Primary Market
The primary market is the market for new securities or shares. A primary market is a company selling new securities to an investor in exchange for cash (buyer). It deals with trading new stock issues and other securities sold to investors.
- Secondary Market
The secondary market is concerned with the exchange of existing or previously issued securities between investors. Once new securities have been sold in the primary market, they must be resold in an efficient manner. Secondary markets enable investors to resell or trade existing securities. Another important distinction in the capital market is made based on the type of security sold or purchased, namely the stock market and the bond market.
How Does a Capital Market Work?
A capital market helps an economy by providing a platform for raising funds for business operations, development activities, or wealth accumulation. A capital market operates according to the circular flow of money theory.
A company, for example, requires funds for business operations and typically borrows from households or individuals. Individual investors’ or households’ money is invested in a company’s shares or bonds in the capital market. As a result, investors receive profits as well as goods and services in exchange.
The market consists of finance suppliers and buyers, as well as trading instruments and mechanisms. There are also governing bodies. Capital markets include stock exchanges, equity markets, debt markets, options markets, etc.
Elements of a Capital Market
- The market’s major fund suppliers include individual investors, commercial banks, financial institutions, insurance companies, business corporations, and retirement funds.
- Investors offer money intending to profit from capital gains as their investment grows over time. They also receive benefits such as dividends, interest, and ownership rights.
- Companies, entrepreneurs, governments, and others are all looking for funding. For example, the government issues debt instruments and deposits to fund the economy and development projects.
- Long-term investments such as shares, debt, government securities, debentures, bonds, and so on are typically traded here.
- In addition, hybrid securities such as convertible debentures and preference shares exist.
- The market is primarily operated by stock exchanges. Investment banks, venture capitalists, and brokers are examples of other intermediaries.
- Regulatory bodies are empowered to monitor and eliminate illegal activities in the capital market. The Securities and Exchange Commission, for example, oversees stock exchange operations.
- The capital and money markets are not the same thing. Securities traded in the former are typically long-term investments with a one-year lock-in period. Certificates of deposit, bills of exchange, promissory notes, and other short-term investments are traded in the money markets.
Functions of Capital Market
- Capital Formation:
There are two types of people in the capital markets: investors who don’t need money right away and debtors who do. The capital markets enable leftover funds to be invested and used rather than sitting idle. As a result, rather than having 1 crore sitting in the locker, firms can borrow money and invest in new machinery or other capital equipment. In return, the investor receives a dividend, and the company gains access to more efficient machinery. This capital market role examines the economy on a macro scale.
- Absence of Entry and Exit Barriers:
Today’s investors primarily trade on the capital markets via mobile devices, making them more accessible than ever. The spread of technology has made financial markets virtually accessible to everyone. As soon as an investor opens an account with a broker, they are practically ready to invest. Furthermore, there are now global marketplaces. People can exit the market just as quickly as they entered due to increased demand for assets.
- Economic Development:
The capital market fosters a marketplace for borrowers and lenders, resulting in a more efficient flow of cash. Businesses in need of corporate loans can apply on the capital market, and the loan will be issued by an underwriter. It can also raise funds by selling a portion of its business on the stock market.
Simply put, it boosts demand. Businesses that require credit can invest if it is granted to them. The company that provides the capital equipment that it has invested in receives the money. As a result of the circulation of that money, the economy can continue to grow. This is regarded as one of the most important roles of the capital market.
- Capital Liquidity:
Because of the financial markets, people with money can invest it. In exchange, they receive ownership of a bond or stock. They cannot, however, use a bond certificate to buy a car, food, or other assets, so they may need to liquidate them. Investors can easily sell their assets to a third party on the capital markets in exchange for liquid funds (cash). If you want to sell an item at the current market price, there is almost always a buyer, allowing you to convert the asset into actual cash.
- Price Regulation:
One of the primary goals of capital markets is to ensure that the price of an asset is accurate. A stock’s price may rise in response to good news or fall in response to a poor annual report. Because of the thousands of traders, the prices fluctuate to the point where the equity worth is represented in its price at the time. Bond prices can change and adapt more quickly as a result of simultaneous supply and demand. During a recession, for example, investors typically prefer bonds because they are perceived as a safer investment.
- Provides Opportunities for Investors:
Whether an investor prefers a high or low level of risk, the capital markets have enough financial instruments to meet their needs. At the same time, capital markets allow investors to increase their capital yield. Savings accounts pay very little interest, especially when compared to most equities’ rates. As a result, the capital market allows investors to earn a higher rate of return, though there is some risk involved. This function of the capital market benefits the investors who participate in it.