What Are Capital Markets?

What Are Capital Markets and Its Functions?

Any person or business working with money, which off course are all of us, work with capital and some form of investment. If you have a personal or business bank account, you are unknowingly participating in capital market trading, as this is how all money is invested.

In short, the capital market is the place where capital or financial suppliers and those in need of capital or finance interact through investments with different financial instruments. Because of this, it is a fan-tastic source of income for companies through its availability of a large spectrum of investment ap-proaches.

Types of capital markets

Even though capital markets have the same goal in sight – the trading of assets and securities, the capi-tal market can conveniently be devised into two broad divisions based on the status of the assets and securities they deal with.

Primary capital market

The primary market is also called the New Issue Market, because is is exclusively available for the trading of new securities. It mainly serves as capital formation under Initial Public Offer (IPO) for government organizations, institutions and companies.

This type of market has a threefold purpose in that it examines and evaluates new proposals before submission to the capital market, with the help of commercial bankers. Secondly, it secures underwrit-ers, or financial backing, for each new issue. Underwriters basically vow their monetary support of this new submission in case no sales are made on the open market.

Finally, brokers and dealers are employed to distribute or ‘sell’ these new submissions to investors by promoting investment in these new securities.

Secondary capital market

The secondary market is more commonly known as the stock exchange or stock market, and it is the trading platform for known securities that have been traded for a while and have a history that can be used for prediction. It serves the purpose of providing up to date information on the value of each secu-rity listed, while allowing continuous active trading.

Finally, it also offers investors the option to liquefy their assets. Beyond that, the secondary capital market can be subdivided into debt and equity markets.

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Equity capital markets vs. debt capital markets

Investment banking offers a variety of investment choices to its clients in the form of product and in-dustry groups. Equity capital markets and debt capital markets are simply examples of such product groups, where an investor can either choose to invest their capital in building equity, or in financing debt (Source).

They are both lucrative ways of increasing your capital, and which one you choose might depend on the political and economic climate and your own personal choice.

  • Equity capital market

    Investing in equity can be seen as investing in a specific company, by buying a share of ownership in that company. This boosts the company’s capital, while offering the investor a monetary reward, ei-ther by the increase in value of that share – so it can be resold at a higher price, or by receiving divi-dends (Source).

    Unfortunately, the equity market is volatile by nature, and it is possible to loose your investment if the company you invested in goes under. Because of this risky nature, returns can be substantially higher than less risky investments such as bonds.
  • Debt capital market

    Debt securities are a much safer investment option, in that the market is not that volatile. On the other hand, the promise of returns are lower, but steadier and more secure. The most common form of debt investments are bonds, which are issued by governments of corporations to generate cash, while offer-ing fixed interest rate over a fixed term (Source).

    Some other examples of debt investment include real estate and mortgage debt investment, which can be quite complex and tricky, and is best handled by experienced investors.

Conclusion

The takeaway message of this post is that capital markets create fair trading platforms for various forms of financial securities, that in the end promote economic growth and capital creation through indirect monetary transfer.

Once a new security is ready to be listed, it must first be evaluated and approved before it can be traded on the primary capital market. Once a security has been traded, it can be made available on the secondary capital market and can be categorized into one of two broad groups namely debt or equity investments. Of these two, debt investments are less risky, and offer a more relia-ble return compared to the riskier equity investments.

Ultimately, what you invest in will depend on your risk profile, knowledge, and the current eco-nomic climate. To that end, it is always important to not keep all your eggs in one basket – no matter where you invest!