Capital market is referred to as a place where saving and investments are done
between capital suppliers and those who are in need of capital. It is, therefore,
a place where various entities trade different financial instruments.
Capital markets deal with long term debt that allows businesses and
governments to secure capital to allow them to invest and provide public
services.
capital markets deal with long term debt such as stocks and bonds – whereby
the capital is used for long term investments that expand the business and
increase revenues.
The Two Types of Capital Markets
The primary market is a new issue market; it solely deals with the issues of
new securities. A place where trading of securities is done for the first time.
The main objective is capital formation for government, institutions,
companies, etc. also known as Initial Public Offer (IPO).
There are two main types of financial instruments that are traded in the
primary capital market. They are equities (stocks) and debt. Equities are
commonly bought and sold via the stock market such as the New York Stock
Exchange.
The secondary market is a place where trading takes place for existing
securities. It is known as stock exchange or stock market. Here the securities
are bought and sold by the investors.
In the secondary capital markets, stocks are traded between investors through
stock markets such as the London Stock Exchange, the Tokyo Stock Exchange,
and the New York Stock Exchange – among many more. Those who no longer
want specific stocks sell them on the exchange. These are then ‘liquidated.
Functions of Capital Markets
1. Capital Formation
In capital markets, there are people who have no immediate need for cash –
investors – and those who need cash – debtors. The capital markets allow
unused capital to be invested and employed instead of sitting by idle.
So rather than have $1 million sitting under the mattress, it allows businesses
the opportunity to borrow and invest in new machinery or other capital
equipment. In return, the investor receives a yield and the business benefits
from more productive equipment.
2. Ease of Access and Exit
In today’s day and age, capital markets have become increasingly accessible,
with investors able to trade off their mobiles. The advancement of technology
has made capital markets almost universally available.
All investors have to do is create an account with a broker and they are
essentially ready to invest. At the same time, we now have global markets too.
So that also creates greater demand for assets too – meaning people can exit
the market as easily as they joined.
3. Economic Growth
By facilitating a market place for borrowers and lenders, the capital market
creates a more efficient flow of capital. Businesses that need a corporate loan
can come to the capital market, apply, and get it issued by an underwriter.
Alternatively, it can sell some of its company onto the stock exchange in return
for capital.
This helps economic growth because it takes capital that is not being used, and
it employs it somewhere else in the economy. Quite simply, it stimulates
demand. If businesses that need credit get it, they are able to invest. In turn,
that money goes to the business that provides the capital equipment that it
invested in. That money then can circulate further and further through the
economy – meaning an initial $1 million investment turns into $10 million after
being exchanged 10 times.
4. Liquidity of Capital
Capital markets allow those who have capital, to invest it. In return, they have
ownership of a bond or equity. However, they are unable to buy a car, food, or
other assets with a bond certificate – which is why it may be necessary to
liquidate these.
In capital markets, it is very easy for those who have previously invested, to sell
the asset on to a third party in return for liquid capital (cash). If you want to
sell an asset at the current market price, there is almost always a buyer –
allowing you to turn an asset into cold hard cash.
5. Regulate Prices
One of the key functions of capital markets is to ensure the price of an asset is
accurate. The price of a share can increase rapidly following good news, or
tank badly in reaction to a poor annual report. By having thousands of traders,
the prices fluctuate to a point whereby the value of the equity is reflected in its
price at that time.
At the same time, the prices for bonds can fluctuate and respond more
effectively due to supply and demand. For instance, bonds are usually seen as
a safer investment – so are usually preferred by investors during a recession.
6. Return on Investment
In capital markets there are enough financial instruments to suit any type of
investors, whether they want a high level of risk or a low level of risk – there is
something for everyone.
At the same time, capital markets provide investors with an opportunity to
enhance their yield on their capital. Savings accounts offer little interest –
particularly in comparison to yields on the majority of stocks. The capital
market, therefore, allows investors the opportunity to make a higher rate of
return – although there is an element of risk too.