What Are Capital Markets?
Capital markets are where savings and investments are channeled between suppliers—people or institutions with capital to lend or invest—and those in need. Suppliers typically include banks and investors while those who seek capital are businesses, governments, and individuals.
Capital markets seek to improve transactional efficiencies. These markets bring suppliers together with those seeking capital and provide a place where they can exchange securities.
- Capital markets refer to the venues where funds are exchanged between suppliers of capital and those who demand capital for use.
- Primary capital markets are where new securities are issued and sold. The secondary market is where previously issued securities are traded between investors.
- The best-known capital markets include the stock market and the bond markets.
Understanding Capital Markets
Capital market is a broad term 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 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—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 vs. Secondary Markets
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 or dog 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.
The secondary market, on the other hand, 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 (NYSE) 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 the 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 the primary capital market, while traders and investors subsequently buy and sell those securities among one another on the secondary 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 (IPO) when shares become listed 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.