Capital Market

What are Capital Markets?

A capital market is a place that allows the trading of funding instruments such as shares, debentures, debt instruments, bonds, ETFs, etc. It is a source for raising funds for individuals, firms and governments.

The securities exchanged here would typically be a long-term investment with a lock-in period of over a year. On the other hand, short-term investments are usually found in the money marketMoney MarketThe money market is a market where institutions and traders trade short-term and open-ended funds. It enables borrowers to readily meet finance requirements through any financial asset that can be readily converted into money, providing an organization with a high level of liquidity and transferability.read more.

Key Takeaways
Capital Market

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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 operationsBusiness OperationsBusiness operations refer to all those activities that the employees undertake within an organizational setup daily to produce goods and services for accomplishing the company's goals like profit generation.read more 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 marketEquity MarketAn equity market is a platform that enables the companies to issue their securities to the investors; it also facilitates the further exchange of these stocks between the buyers and sellers. It comprises various stock exchanges like New York Stock Exchange (NYSE).read more, debt market, options market, etc., are some capital market examples.

Types of Capital Market

Types of Capital Market

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#1 – Primary Market

The primary market is a market for trading freshly issued securities, i.e., first time trading. It is also known as the new issues market. It enables initial public offering.

Usually, the intermediary, like an investment bank, 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. Here, companies raise funds with the help of preferential allotment, rights issue, electronic IPOs, or the pre-selected issue of securities or private placement.

#2 – Secondary Market

The trading of old securities occurs in the secondary market, which takes place after transacting in the primary market first. We also call this market the stock market or aftermarket. Both stock markets and over-the-counter trades come under the secondary market.

Examples of secondary markets are the London Stock Exchange, the New York Stock Exchange, NASDAQ, etc.

Elements of a Capital Market

Functions of Capital Market

  • It mobilizes the savings of parties from cash and other forms to financial markets. Thereby, it bridges the gap between people who supply capital and people in need of money.
  • Any initiative requires cash to materialize. Financial markets are central to national and economic development as they provide rich sources of funds. For example, the World Bank collaborates with global capital markets to mobilize funds to achieve its goals, such as poverty elimination.
  • The International Bank for Reconstruction and Development (IBRD) has assisted over 70 countries by raising nearly $ 1 trillion since the first bond in 1947. Likewise, a report suggested that the European Union companies need to turn to this market to manage their pandemic ravaged balance sheet as banks alone will not suffice.
  • For the participants, the instruments of exchange possess liquidityLiquidityLiquidity shows the ease of converting the assets or the securities of the company into the cash. Liquidity is the ability of the firm to pay off the current liabilities with the current assets it possesses.read more, i.e., they can be converted into cash and cash equivalents.
  • Also, the trading of securities becomes easier for investors and companies. It helps minimize transaction and information costs.
  • With higher risks, investors can gain more profits. However, there are many products for those with a low-risk appetite. In addition, there are some tax benefits attained from investing in the stock market.
  • Usually, the market securities can work as collateral for getting loans from banks and financial institutions.

Downsides

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 and debt instruments, etc. The most common example is a stock exchange such as NASDAQ, trading shares from different companies amongst investors.

What are the types of capital markets?

They are of two types –
• Primary market – deals with fresh stocks.
• Secondary market – trading with old securities.

Recommended Articles

This article has been a guide to the capital market and its meaning. Here we discuss its functions, types of the capital market along with advantages and disadvantages. You can learn more about financing from the following articles –

Reader Interactions

Comments

  1. AvatarAbdul Azim says

    To good

    Thanks!!

    • AvatarDheeraj Vaidya says

      Thanks for your kind words!

  2. AvatarAlhassan Khadijat says

    Well, capital market seems to have many advantages such as : it helps in the economic growth, help to provide a better future for all through the stock market, and lastly, it helps to provide money to those who want to start a business.

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