Table of Contents
What Are Capital Markets?
Let me explain capital markets directly to you: they are the financial exchanges where companies and governments needing cash to operate or expand sell assets to investors who have money to lend or invest. You probably know the stock, bond, and commodities markets as prime examples of these.
These markets exist to bring buyers and sellers together efficiently. Their physical locations matter less now because most transactions happen electronically.
Key Takeaways
In capital markets, sellers are mainly companies and governments raising cash to finance or expand operations. Buyers include individual investors, mutual fund managers, or institutional players like banks. This covers the stock market for ownership shares and the bond market for interest-bearing debts.
How Capital Markets Work
The term capital market broadly describes in-person and digital spaces where entities trade financial instruments. Think of the stock market, bond market, and currency or forex markets. Most are centered in places like New York, London, Singapore, and Hong Kong.
These markets consist of fund suppliers and users. Suppliers are households via savings accounts, plus institutions like pension funds, life insurance companies, foundations, and nonfinancial firms with extra cash.
Capital markets play a crucial role in modern economies by moving money from those who have it to those who need it for productive use.
Users of these funds include buyers of homes or vehicles, nonfinancial companies, and governments funding infrastructure or operations. Primarily, though, capital markets sell equities—stocks representing company ownership—and debt securities like bonds, which are interest-bearing IOUs.
Primary vs. Secondary Markets
Capital markets split into two categories: primary markets for selling new equity stocks and bonds to investors, and secondary markets for trading existing securities.
Primary Markets
A company enters the primary capital market by selling new stocks or bonds publicly for the first time, like in an initial public offering (IPO). This is also called the new issues market. The company hires an underwriting firm, which reviews and creates a prospectus with price and details.
All primary market issues face strict regulation. Companies must file with the SEC and other agencies, waiting for approval before going public.
Small investors often can't buy in because companies and bankers aim to sell quickly to meet volume, focusing on large investors. Marketing involves roadshows where bankers and leaders pitch the security's value to potential buyers.
Secondary Markets
The secondary market, overseen by bodies like the SEC, is where investors trade previously issued securities. Issuing companies aren't involved. Examples include the NYSE and Nasdaq.
It has two types: auction markets with open outcry where buyers and sellers announce prices in one spot, like the NYSE, and dealer markets where trading happens electronically through networks. Most small investors use dealer markets.
Are Capital Markets the Same As Financial Markets?
There's overlap, but key differences exist. Financial markets cover venues where people and organizations exchange assets, securities, and contracts, often as secondary markets. Capital markets focus on raising funds for operations or growth, usually for firms.
How Is a Primary Market Different From a Secondary Market?
In the primary market, new capital is raised by issuing and selling stocks and bonds to investors. In the secondary market, traders and investors buy and sell these securities among themselves, with no new capital going to the firm.
What Markets Do Firms Use to Raise Capital?
Firms seeking equity can use private placements with angel or venture investors, but the biggest sums come from IPOs on the stock market. For debt, they turn to bank loans or bond market securities.
The Bottom Line
Capital markets are vital to the financial industry, linking capital suppliers with seekers like governments for infrastructure, businesses for expansion, or individuals for homes. They divide into primary markets for new issues and secondary markets for trading existing ones. The main advantage is moving money from haves to needs for their purposes.
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