What Are Capital Markets?
Capital markets are venues where savings and investments are channeled between the suppliers who have capital and those who are in need of capital. The entities that have capital include retail and institutional investors while those who seek capital are businesses, governments, and people.
Capital markets seek to improve transactional efficiencies. These markets bring those who hold capital and those seeking capital together and provide a place where entities can exchange securities.
- Capital markets refer to the places where savings and investments are moved between suppliers of capital and those who are in need of capital.
- Capital markets consist of the primary market, where new securities are issued and sold, and the secondary market, where already-issued securities are traded between investors.
- The most common capital markets are the stock market and the bond market.
Understanding Capital Markets
The term capital market broadly defines the place where various entities trade different financial instruments. These venues may include the stock market, the bond market, and the currency and foreign exchange markets. Most markets are concentrated in major financial centers including New York, London, Singapore, and Hong Kong.
Capital markets are composed of the suppliers and users of funds. Suppliers include households and the institutions serving them—pension funds, life insurance companies, charitable foundations, and non-financial companies—that generate cash beyond their needs for investment. Users of funds include home and motor vehicle purchasers, non-financial companies, and governments financing infrastructure investment and operating expenses.
Capital markets are used 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—and 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 Versus Secondary Capital Markets
Capital markets are composed of primary and secondary markets. The majority of modern primary and secondary markets are computer-based electronic platforms.
Primary markets are open to specific investors who buy securities directly from the issuing company. These securities are considered primary offerings or initial public offerings (IPOs). When a company goes public, it sells its stocks and bonds to large-scale and institutional investors such as hedge funds and mutual funds.
The secondary market, on the other hand, includes venues overseen by a regulatory body like the Securities and Exchange Commission (SEC) where existing or already-issued securities are traded between investors. Issuing companies do not have a part in the secondary market. The New York Stock Exchange (NYSE) and Nasdaq are examples of the secondary market.
The secondary market serves an important purpose in capital markets because it creates liquidity, giving investors the confidence to purchase securities.
Capital Markets Expanded
Capital markets can refer to markets in a broad sense for any financial asset.
In this realm, the capital market is where investable capital for non-financial companies is available. Investable capital includes the external funds included in a weighted average cost of capital calculation—common and preferred equity, public bonds, and private debt—that are also used in a return on invested capital calculation. Capital markets in corporate finance may also refer to equity funding, excluding debt.
Financial companies involved in private rather than public markets are part of the capital market. They include investment banks, private equity, and venture capital firms in contrast to broker-dealers and public exchanges.
Operated by a regulated exchange, capital markets can refer to equity markets in contrast to debt, bond, fixed income, money, derivatives, and commodities markets. Mirroring the corporate finance context, capital markets can also mean equity as well as debt, bond, or fixed income markets.
Capital markets may also refer to investments that receive capital gains tax treatment. While short-term gains—assets held under a year—are taxed as income according to a tax bracket, there are different rates for long-term gains. These rates are often related to transactions arranged privately through investment banks or private funds such as private equity or venture capital.