Capital markets refer to those marketplaces for the sales and purchase of both debt and equity financial issues. These markets move investments and savings back and forth between capital suppliers like institutional and retail investors to capital users. These are individual entrepreneurs, businesses and corporations, and governmental agencies. Economies do not function efficiently or successfully without such liquid markets of capital. This is because capital is a crucial component for producing economic output.
There are two types of such capital markets. These include the primary markets and secondary markets. In the primary markets, investors buy and sell new bond and stock instruments. Secondary markets are the ones that trade already existing securities. The two financial instruments categories are equities and debt securities. The equities are typically called stocks. The debt securities are usually called bonds. Such markets revolve around the selling of bonds and stocks for longer and medium term durations, typically of at least a year.
These capital markets in the United States function under the auspices of the Securities and Exchange Commission. In other nations, they operate under different financial regulators. In general, such markets tend to cluster in the several important financial centers of the globe. The greatest of these are London, New York City, Hong Kong, and Singapore. Despite the fact that the markets lie in these principal city centers, the majority of their trades happen via sophisticated electronic and computer trading systems. While members of the public can access some such capital centers in person, the other ones remain highly secured and regulated.
Primary markets are where these investments first appear. The companies which need to raise capital issue bonds and stocks directly to the financial institutions, businesses, and investors here. They typically buy these in a process called underwriting. Another advantage offered by companies which require capital is that they can do it there without having to hold initial public offerings (IPOs) so that the profit remains theirs. When companies do opt for IPOs, they typically sell all of their stock shares off to several underwriting investment banks through a lead investment bank and other financial firms which choose to participate.
From this stage, the new shares become a part of the secondary market. Here the investment banks, financial firms, and private investors are allowed to resell their debt and equity instruments to retail investors.
There are many entities which participate in capital markets. These include institutional investors like mutual funds and pension funds, retail investors, corporations and other organizations, governments and municipalities, and financial institutions and banks. Governments may be allowed to issue bonds on these markets, but they can never sell equity via stocks.
These markets are where supply and demand between capital suppliers and users meet and adjust. While capital users desire to raise their capital for the lowest cost they possibly can, the suppliers wish to obtain the highest return they possibly can for the least amount of risk possible.
A country’s capital markets’ size will be directly proportional to the economic size of the nation in question. As the biggest economy on the planet, the U.S. boasts the deepest and biggest capital markets. These markets are still interdependent on other such capital centers in the global economy of today. Small ripples in another center such as London or Hong Kong can lead to substantial waves in Singapore and/or New York City.
The downside to the interconnectedness of the financial and capital centers is illustrated by the financial and credit crisis of 2007 to 2009. It was actually the failure of the mortgage-backed securities markets in the United States that triggered the crisis and collapse. This de facto meltdown in the U.S. became transmitted around the world by the global capital markets as financial institutions, investment banks, and commercial banks throughout both Europe and Asia were holding literally trillions of U.S. dollars worth of such securities.