Beginnings
Capital markets can be traced back to the dawn of human civilization, when farmers and traders needed a way to finance their operations. In the 17th century, the Netherlands established the first known capital market. Requiring funds to support its endeavors, the Dutch East India Company utilized stocks to secure capital from the public, initiating a practice of buying and selling these shares.
This marked the genesis of a securities trading arena, ultimately giving rise to the renowned Amsterdam Stock Exchange , recognized as the globe’s oldest stock exchange.
Definition
Capital markets are financial markets in which businesses, governments, and other organizations raise long-term funding by selling securities such as stocks, bonds, and other debt instruments. They enable investors to invest in these securities, thereby providing a source of funding for the issuer.
Capital markets are usually classified into two types: primary markets and secondary markets.
Primary vs secondary market
| Feature | Primary Market | Secondary Market |
|---|---|---|
| Definition | Where new securities are issued and sold to the public for the first time | Where securities that have already been issued are bought and sold by investors |
| Examples | Initial public offerings (IPOs), corporate bond issuances | Stock exchanges (e.g. NYSE, NASDAQ), over-the-counter (OTC) markets, online trading platforms (e.g. E*TRADE, Robinhood) |
| Purpose | Raising capital for issuers | Facilitating the buying and selling of existing securities among investors |
| Risk | Higher risk due to untested securities | Lower risk due to established securities |
| Market participants | Issuers, underwriters, institutional investors | Individual investors, traders, market makers |
| Price determination | Issuer sets initial offering price | Supply and demand determines market price |
| Liquidity | Generally lower liquidity | Generally higher liquidity |
| Pros | • Allows issuers to raise new capital by selling securities to investors. • Assists in determining the market price for new securities. • Can result in media attention and publicity for the issuer. | • Liquidity to investors by making it simple for them to buy and sell securities. • Assists in determining the market price of securities. Gives investors the opportunity to profit by buying low and selling high. • Allows investors to diversify their portfolios by investing in a variety of securities. |
| Cons | • Preparing for and carrying out a primary market transaction can be costly and time-consuming for issuers. • Issuers may be required to relinquish some control or ownership of the company to new investors. • Securities may be subject to regulatory scrutiny and approval processes, causing the issuance process to be delayed. | • Secondary market prices for securities can be volatile and subject to sudden changes in market conditions. • When buying and selling securities, investors may be required to pay brokerage fees and other transaction costs. • Trading volumes may fluctuate significantly, affecting market liquidity. • Securities may be subject to regulatory and legal risks, such as insider trading or fraud. |
Types
Capital markets are further classified based on the securities traded, the duration of the securities, and the parties involved.
The following are the most common types of capital markets:
| Market Type | Definition | Examples |
|---|---|---|
| Stock market | Market for trading shares of publicly traded firms | New York Stock Exchange (NYSE), NASDAQ |
| Bond market | Market for trading debt securities | U.S. Treasury bonds, corporate bonds |
| Foreign exchange market | Market for trading currencies | Forex market, currency futures markets |
| Commodity market1 | Market for trading physical goods | Gold2, oil, agricultural commodities |
| Crypto market3 | Market for trading cryptocurrencies | Bitcoin4, Ethereum, Litecoin |
Instruments
The capital market provides investors with a variety of financial instruments to buy and sell. Here are some of the most important capital market instruments, along with concrete examples of each:
1. Stocks
The most well-known financial instruments traded on the capital market are stocks. Stocks represent ownership in a company and their value is determined by market supply and demand. Apple Inc. (AAPL), Amazon.com Inc. (AMZN), and Tesla Inc. (TSLA) are examples.
2. Bonds
Bonds are a type of debt instrument issued by corporations or governments to raise funds. Investors who purchase bonds are effectively lending money to the issuer and will receive interest payments until the bond matures, at which point they will receive their principal back. US Treasury Bonds, Corporate Bonds, and Municipal Bonds are examples.
3. ETFs
ETFs are exchange-traded funds that track the performance of an underlying asset, such as an index or a commodity. ETFs are traded similarly to stocks and offer investors exposure to a diverse portfolio of securities. Examples include the SPDR S&P 500 ETF Trust (SPY), Invesco QQQ Trust (QQQ), and iShares Core MSCI EAFE ETF (IEFA).
Regulations
• Reguarly disclosures: Companies that sell securities on a capital market may be required to make regular disclosures about their financial performance and other key metrics.
• Regulatory oversight: Regulatory bodies such as the Securities and Exchange Commission (SEC) in the United States and the Financial Conduct Authority (FCA) in the United Kingdom may monitor capital markets.
Chances for companies
Capital markets can help companies in a number of ways, including:
1. Raising Capital
Companies can raise capital by issuing securities in the capital markets, such as stocks and bonds, to fund their growth, expansion, and other business activities. This enables businesses to obtain funds that they would not have been able to obtain through traditional means, such as bank loans.
2. Offering Flexibility
Capital markets offer businesses a versatile funding source that can be customized to suit their specific needs. Companies have the ability to design their offerings to match their financial requirements, choosing from a range of securities like equity or debt.
FAQ
Blackrock capital market assumptions
According to BlackRock’s Capital Market Assumptions (CMAs) for 2023 most asset classes are expected to deliver stronger returns than in 2022.
The CMAs take into account a wide range of asset classes, including equities, government bonds, investment grade credit, sub-investment grade credit, and private markets. Fee estimates for various asset types range from 0.1% to 5.0%, depending on the asset class.
International capital market association
The International Capital Market Association (ICMA) is a non-profit organization established in Switzerland that functions as an international capital market trade organisation. ICMA provides a venue for its members to discuss and establish capital market standards, such as market conventions, legal and regulatory frameworks, and market best practices. Banks, financial institutions, law firms, and other industry stakeholders are among its members.
Which among the following is not considered a capital market instrument?
1. Bank accounts: Because they do not involve the trade of securities or ownership in a corporation, bank accounts are not capital market instruments.
2. Insurance policies: Insurance policies are not capital market instruments because they are contracts between a person and an insurance business rather than securities traded on a market.