Basics of Capital Market - Elements, Types, And How Does It Work
A capital market is a financial market palace where different financial securities, such as shares, bonds, debentures, and more, are traded between various entities. This article provides CS executive students with a brief overview of the functioning of the capital market.
Rahul Jaiswal8 Jul, 2024
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A capital market, one of the important topics of the CS Executive Exam , is a financial marketplace where long-term securities such as shares, debentures, debt instruments, bonds, and ETFs are traded. It serves as a vital platform for raising funds and fulfilling the needs of individuals, firms, and governments. Unlike money markets, which focus on short-term investments, capital markets deal with investments that typically exceed a year.
In capital markets, suppliers of capital, including banks, individual investors, and institutions managing pension funds or life insurance, connect with those seeking capital. These include governments funding infrastructure projects and individuals making significant purchases. The market facilitates the efficient movement of funds by exchanging financial assets like equities and bonds. This process supports economic growth by enabling capital flow to where it is needed most, making capital markets essential to a nation's economic development.Key Elements of a Capital Market
Capital markets are composed of various elements that work together to facilitate the buying and selling of securities. These elements ensure the market's smooth functioning, transparency, and efficiency, enabling investors and issuers to engage in transactions that support economic growth and development. Below are the key components that make up the structure of capital markets :- Securities: These include stocks, bonds, debentures, and other financial instruments.
- Investors: Individuals, institutions, mutual funds, pension funds, and insurance companies that buy and sell securities.
- Intermediaries: Entities such as brokers, investment banks, and financial advisors that facilitate transactions.
- Regulatory Bodies: Organizations that regulate market activities to ensure compliance with laws and protect investors .
- Exchanges: Platforms like the New York Stock Exchange (NYSE) and the Bombay Stock Exchange (BSE) where securities are traded.
Types of Capital Markets
The capital market is divided into two main types. These are as follows: Primary Market: This is where new securities are issued and sold for the first time. Initial Public Offerings (IPOs) are a common example of primary market transactions. Secondary Market In the secondary market, existing securities are traded among investors. The stock exchange is the most prominent example of a secondary market, where investors buy and sell shares without directly involving the issuing companies.How Do Capital Markets Work?
The capital market serves as a trading platform for cash and securities, which is significant in linking investors with companies that require funding. Companies seeking to operate efficiently often turn to the capital market to raise funds, and one of the most effective ways to do this is through a public offering on the stock markets. This process can take two forms:- Selling equity securities (shares) or
- Debt securities (bonds).
Functions of the Capital Market
The main goals of the capital market are:- To gather resources for investments
- To help in buying and selling securities
- To aid in finding the fair prices of securities
- To ensure transactions are settled on time
Why There is a Need for a Capital Market?
Here are several key reasons why capital markets are indispensable:- Capital Formation : These markets enable companies and governments to raise funds by issuing securities essential for growth and development.
- Efficient Resource Allocation : By offering various investment options, capital markets ensure that capital is directed toward its most productive uses.
- Debt Management : Capital markets allow the issuance of debt, which is a more efficient and less restrictive form of borrowing for corporations. They balance the interests of borrowers and investors, acting as buffers during economic stress or market turmoil.
- Liquidity : These markets offer high liquidity, allowing investors to quickly and easily buy and sell securities, thus freeing up capital for other investments.
- Risk Management : Capital markets offer a range of risk management tools, such as derivatives, which allow investors to manage their exposure to various types of risks.
- Building Wealth : These markets help people build wealth and invest in their future. Investors can invest in various securities, including stocks, ETFs, mutual funds, and corporate bonds. Individuals can use the invested principal and any corresponding appreciation to invest in their pension, buy their own home, or save for higher education.
- Innovation : Capital markets fuel companies or entrepreneurs to turn ideas or industrial innovations into real businesses or expansions for existing companies. This, in turn, creates jobs
Basics of Capital Market FAQs
What is a capital market?
A capital market is a financial market where individuals and firms borrow funds by issuing and trading long-term securities like stocks and bonds.
How do capital markets differ from financial markets?
Capital markets specifically deal with long-term funding and investments, while financial markets encompass a broader range of trading activities, including long-term and short-term instruments.
Are capital markets efficient?
While capital markets are not perfectly efficient, they generally reflect current market information in the prices of securities to some extent.
What are examples of capital markets?
Examples include organized stock exchanges like the New York Stock Exchange (NYSE), London Stock Exchange (LSE), and NASDAQ, where shares and bonds are traded.
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