What Are Capital Markets, and How Do They Work? (2024)

What Are Capital Markets?

Capital markets are where savings and investments are channeled between suppliers and those in need. Suppliers are people or institutions with capital to lend or invest and typically include banks and investors. Those who seek capital in this market are businesses, governments, and individuals. Capital markets are composed of primary and secondary markets. The most common capital markets are the stock market and the bond market. They seek to improve transactional efficiencies by bringing suppliers together with those seeking capital and providing a place where they can exchange securities.

Key Takeaways

  • 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.

Understanding Capital Markets

The term capital market is a broad one that is used to describe the in-person and digital spaces in which various entities trade different types of financial instruments. These venues may include the stock market, the bond market, and the currency and foreign exchange (forex) markets. Most markets are concentrated in major financial centers such as New York, London, Singapore, and Hong Kong.

Capital markets are composed of the suppliers and users of funds. Suppliers include households (through the savings accounts they hold with banks) as well as institutions like pension and retirement funds, life insurance companies, charitable foundations, and non-financial companies that generate excess cash. The users of the funds distributed on capital markets include home and motor vehicle purchasers, non-financial companies, and governments financing infrastructure investment and operating expenses.

Capital markets are used primarily to sell financial products such as equities and debt securities. Equities are stocks, which are ownership shares in a company. Debt securities, such as bonds, are interest-bearing IOUs.

These markets are divided into two different categories:

  • Primary markets where new equity stock and bond issues are sold to investors
  • Secondary markets, which trade existing securities

Capital markets are a crucial part of a functioning modern economy because they move money from the people who have it to those who need it for productive use.

Primary vs. Secondary Markets

Primary Market

When a company publicly sells new stocks or bonds for the first time, such as in an initial public offering (IPO), it does so in the primary capital market. This market is sometimes called the new issues market. When investors purchase securities on the primary capital market, the company that offers the securities hires an underwriting firm to review it and create a prospectus outlining the price and other details of the securities to be issued.

All issues on the primary market are subject to strict regulation. Companies must file statements with the Securities and Exchange Commission (SEC) and other securities agencies and must wait until their filings are approved before they can go public.

Small investors are often unable to buy securities on the primary market because the company and its investment bankers want to sell all of the available securities in a short period of time to meet the required volume, and they must focus on marketing the sale to large investors who can buy more securities at once. Marketing the sale to investors can often include a roadshow ordog and pony show, in which investment bankers and the company's leadership travel to meet with potential investors and convince them of the value of the security being issued.

Secondary Market

The secondary market includes venues overseen by a regulatory body like the SEC where these previously issued securities are traded between investors. Issuing companies do not have a part in the secondary market. The New York Stock Exchange and Nasdaq are examples of secondary markets.

The secondary market has two different categories: the auction and the dealer markets. The auction market is home to the open outcry system where buyers and sellers congregate in one location and announce the prices at which they are willing to buy and sell their securities. The NYSE is one such example. In dealer markets, though, people trade through electronic networks. Most small investors trade through dealer markets.

Are Capital Markets the Same as Financial Markets?

While there is a great deal of overlap at times, there are some fundamental distinctions between these two terms. Financial markets encompass a broad range of venues where people and organizations exchange assets, securities, and contracts with one another, and are often secondary markets. Capital markets, on the other hand, are used primarily to raise funding, usually for a firm, to be used in operations, or for growth.

What Is a Primary vs. Secondary Market?

New capital is raised via stocks and bonds that are issued and sold to investors in theprimary capital market, while traders and investors subsequently buy and sell those securities among one another on thesecondary capital market but where no new capital is received by the firm.

Which Markets Do Firms Use to Raise Capital?

Companies that raise equity capital can seek private placements via angel or venture capital investors but are able to raise the largest amount through an initial public offering when shares list publicly on the stock market for the first time. Debt capital can be raised through bank loans or via securities issued in the bond market.

The Bottom Line

Capital markets are a very important part of the financial industry. They bring together suppliers of capital and those who seek it for their own purposes. This may include governments that want to fund infrastructure projects, businesses that want to expand, and even individuals who want to buy a home. They are divided into two different categories: the primary market where companies list new issues for the first time and the secondary market, which allows investors to purchase already-issued securities. The key benefit to these markets is that they allow money to move from those who have it to those who need it for their own purposes.

What Are Capital Markets, and How Do They Work? (2024)

FAQs

What are capital markets and how do they work? ›

Capital markets are financial markets that bring buyers and sellers together to trade stocks, bonds, currencies, and other financial assets. Capital markets include the stock market and the bond market.

How to answer why capital markets? ›

Capital markets allow companies to raise money for expansion by allowing traders to purchase and sell stocks and bonds. Since they have trustworthy markets where they can receive money, businesses also have less risk and expenditure when acquiring financial resources.

What are capital markets markets for quizlet? ›

Capital markets are markets for buying and selling equity and debt instruments.

What is capital market answer in one sentence? ›

Capital market is a place where buyers and sellers indulge in trade (buying/selling) of financial securities like bonds, stocks, etc. The trading is undertaken by participants such as individuals and institutions.

What is capital market answer? ›

A capital market is a financial market in which long-term debt (over a year) or equity-backed securities are bought and sold, in contrast to a money market where short-term debt is bought and sold.

What are capital markets for dummies? ›

Capital markets are a way to bring together individuals or institutions with money (also known as capital) they wish to invest, and various entities that seek money to underwrite costs to meet specific purposes.

What is a capital market example? ›

Some examples of capital markets are NASDAQ, BSE, New York Stock Exchange, London Stock Exchange.

What is one of the main purposes of the capital markets? ›

Capital markets provide forums and mechanisms for governments, companies, and people to borrow or invest (or both) across national boundaries. is basically a system in which people, companies, and governments with an excess of funds transfer those funds to people, companies, and governments that have a shortage of ...

What is the role of the capital market? ›

Capital markets play a very important role in the financial industry. They connect capital suppliers with those seeking it. The funding may come from the government, businesses, or even individuals who want to buy a home. These markets help move money from people who have it to people who need it.

What is a capital market quizlet econ? ›

capital markets. Markets for buying and selling stocks and bonds. Capital markets include primary markets, where newly issued stocks and bonds are sold to investors, and secondary markets in which existing stocks and bonds are traded.

What are the capital markets classified into? ›

There are two primary types of capital markets – debt market and equity market – that help businesses raise capital for their growth and development.

What is the difference between a capital market and a money market quizlet? ›

Capital markets are markets in which money is lent for periods longer than a year, while money markets are markets in which money is lent for periods of less than a year.

What is capital market and its advantages? ›

A capital market is a financial marketplace where individuals and institutions buy and sell securities, stocks, bonds, currencies, and other financial assets. Capital markets help people with ideas become entrepreneurs and help small businesses grow bigger.

How do banks make money from capital markets? ›

Investment banks often have market making operations that are designed to generate revenue from providing liquidity in stocks or other markets. A market maker shows a quote (buy price and sale price) and earns a small difference between the two prices, also known as the bid-ask spread.

What is an example of market capital? ›

To calculate market cap, you take the total number of a company's shares outstanding and multiply that figure by the company's current stock price. For example, if a company has 5 million shares outstanding and its current stock price is $20, it has a market capitalization of $100 million.

What is a key difference between capital markets and money markets? ›

The key distinguishing factors are time and rewards. Money markets are made up of short-term investments carrying less risk, whereas capital markets are more geared toward the longer term and offer greater potential gains and losses.

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