In the financial sense, the capital market is the market for the instruments representing the long-term funds requirement of the corporation. It consists of a sprawling complex of institutions and mechanisms whereby intermediate-term funds and long-term funds are pooled and made available to businesses, governments, and individuals. In this mechanism outstanding instruments collecting the funds are transferable.
Key Notes:
Capital markets refer to the venues where funds are exchanged between suppliers and those who seek capital for their own use.
Suppliers in capital markets are typically banks and investors while those who seek capital are businesses, governments, and individuals.
Capital markets are used to sell different financial instruments, including equities and debt securities.
These markets are divided into two categories: primary and secondary markets.
The best-known capital markets include the stock market and the bond markets.
Characteristics of Capital Market
The characteristics of the capital market and its elements may be classified and measured in varieties of ways.
There are a number of submarkets having distinguished features and independent rates of yield. However, the capital markets assume the following characteristics:
Debt and equities instruments traded in the capital markets. are intermediate or longer-term in maturity.
The scope of the market is very wide
The supply of the new funds comes from the same sectors although it is funneled within the markets through financial institutions.
The demand for capital market instruments comes from the categories like individuals and households, businesses and financial corporations, central government, local government, and the foreign government.
Under the auspice of capital markets, both negotiated and open markets are widely used.
Transactions in open markets influence the prices and yields of longer-term instruments immediately.
Long-term instruments in the open market are transferred among the investors in the over-the-counter market and organized exchanges rather than the raising of new funds in the primary markets.
Capital Market Instruments
The major instruments traded in the capital markets are medium and longer-term in maturity which are discussed below:
Treasury Bonds
Government securities with maturity of more than one year. They are marketable and their yields vary with changing credit and capital market conditions
Longer-term debt owned by the government.
Privately owned longer-term debt that is sponsored by the government.
Long-term debt of local government.
Long-term corporate bonds including corporate mortgage debt.
Preferred stocks
Mortgage including residential, commercial, and industrial lien
How Does a Capital Market Work?
A capital market assists an economy by providing a platform to gain funds for business operations, development activities, or wealth enhancement.
The functioning of a capital market follows the theory of the circular flow of money.
For example, a firm needs money for business operations and usually borrows it from households or individuals.
In the capital market, the money from individual investors or households is invested in a firm’s shares or bonds. In return, investors gain profits as well as goods and services.
The market comprises suppliers and buyers of finance, along with trading instruments and mechanisms.
There are also regulatory bodies. Stock exchanges, equity markets, debt markets, options markets, etc., are some capital market examples.
Types of Capital Market
The capital market consists of two types i.e. Primary and Secondary.
Primary Market
The primary market is for trading freshly issued securities, i.e., first-time trading. It enables an initial public offering. It is also known as the new issues market.
Here, companies raise funds with the help of preferential allotment, rights issue, electronic IPOs, or the pre-selected issue of securities or private placement.
Usually, like an investment bank, the intermediary attaches an initial price to the shares.
Once the sale materializes, firms take their shares to the stock exchange to facilitate trading between different investors.
Secondary Market
The trading of old securities occurs in the secondary market, which occurs after transacting in the primary market.
Both stock markets and over-the-counter trades come under the secondary market. We also call this market the stock market or aftermarket.
Examples of secondary markets are the London Stock Exchange, the New York Stock Exchange, NASDAQ, etc.
Elements of a Capital Market
Individual investors, commercial banks, financial institutions, insurance companies, business corporations, and retirement funds are some significant suppliers of funds in the market.
Investors offer money intending to make capital gains when their investment grows with time. In addition, they enjoy perks like dividends, interests, and ownership rights.
Companies, entrepreneurs, governments, etc., are fund-seekers. For instance, the government issues debt instruments and deposits to fund the economy and development projects.
Usually, long-term investments such as shares, debt, government securities, debentures, bonds, etc., are traded here. In addition, there are also hybrid securities such as convertible debentures and preference shares..
Stock exchanges operate the market predominantly. Other intermediaries include investment banks, venture capitalists, and brokers.
Regulatory bodies have the authority to monitor and eliminate any illegal activities in the capital market. For instance, the Securities and Exchange Commission overlooks the stock exchange operations.
The capital market and money market are not the same. Securities exchanged in the former would typically be a long-term investment with over a year lock-in period. Short-term investments trade in the money markets and include a certificate of deposits, bills of exchange, promissory notes, etc.
FAQs
Are capital markets efficient?
Most markets are not perfectly efficient. The capital market is no exception, but to some extent, the prices of securities reflect that they have incorporated the current information in the market.
What is a capital market, and examples?
A capital market is where individuals and firms borrow funds using shares, bonds, debentures, debt instruments, etc.
The most common example is a stock exchange such as NASDAQ, trading shares from different companies amongst investors.
