Capital Markets

DEFINITION OF 'CAPITAL MARKETS'

Capital markets are markets for buying and selling equity and debt instruments. Capital markets
channel
savings
and
investment
between
suppliers
of capital such
as retail
investors and institutional investors, and users of capital like businesses, government and
individuals. Capital markets are vital to the functioning of an economy, since capital is a critical
component for generating economic output. Capital markets include primary markets, where
new stock and bond issues are sold to investors, and secondary markets, which trade
existing securities.

BREAKING DOWN 'CAPITAL MARKETS'

Capital markets are a broad category of markets facilitating the buying and selling of financial
instruments. In particular, there are two categories of financial instruments that capital in which
markets are involved. These are equity securities, which are often known as stocks, and debt
securities, which are often known as bonds. Capital markets involve the issuing of stocks and
bonds for medium-term and long-term durations, generally terms of one year or more.
Capital markets are overseen by the Securities and Exchange Commission in the United States or
other financial regulators elsewhere. Though capital markets are generally concentrated in
financial centers around the world, most of the trades occurring within capital markets take place
through computerized electronic trading systems. Some of these are accessible by the public and
others are more tightly regulated.
Other than the distinction between equity and debt, capital markets are also generally divided into
two categories of markets, the first of which being primary markets. In primary markets, stocks
and bonds are issued directly from companies to investors, businesses and other institutions, often
through underwriting. Primary markets allow companies to raise capital without or before holding
an initial public offering so as to make as much direct profit as possible. After this point in a
companys development, it may choose to hold an initial public offering so as to generate
more liquid capital. In such an event, the company will generally sell its shares to a
few investment banks or other firms.
At this point the shares move into the secondary market, which is where investment banks, other
firms, private investors and a variety of other parties resell their equity and debt securities to
investors. This takes place on the stock market or the bond market, which take place
on exchanges around the world, like the New York Stock Exchange or NASDAQ; though it is
often done through computerized trading systems as well. When securities are resold on the
secondary market, the original sellers do not make money from the sale. Yet, these original
sellers will likely continue to hold some amount of stake in the company, often in the form of
equity, so the companys performance on the secondary market will continue to be important to
them.
Capital markets have numerous participants including individual investors, institutional investors
such as pension funds and mutual funds, municipalities and governments, companies and
organizations, banks and financial institutions. While many different kinds of groups, including
governments, may issue debt through bonds (these are called government bonds), governments
may not issue equity through stocks. Suppliers of capital generally want the maximum
possible return at the lowest possible risk, while users of capital want to raise capital at the lowest
possible cost.
The size of a nations capital markets is directly proportional to the size of its economy. The
United States, the worlds largest economy, has the largest and deepest capital markets. Because
capital markets move money from people who have it to organizations who need it in order to be
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productive, they are critical to a smoothly functioning modern economy. They are also
particularly important in that equity and debt securities are often seen as representative of the
relative health of markets around the world.
On the other hand, because capital markets are increasingly interconnected in
a globalized economy, ripples in one corner of the world can cause major waves elsewhere. The
drawback of this interconnection is best illustrated by the global credit crisis of2007-09, which
was triggered by the collapse in U.S. mortgage-backed securities. The effects of this meltdown
were globally transmitted by capital markets since banks and institutions in Europe and Asia held
trillions of dollars of these securities.

DIFFERENTIATION FROM 'MONEY MARKETS'

People often confuse or conflate capital markets with money markets, though the two are distinct
and differ in a few important respects. Capital markets are distinct from money markets in that
they are exclusively used for medium-term and long-term investments of a year or more. Money
markets, on the other hand, are limited to the trade of financial instruments with maturities not
exceeding one year. Money markets also use different financial instruments than capital markets
do. Whereas capital markets use equity and debt securities, money markets use deposits,
collateral loans, acceptances and bills of exchange.
Because of the significant differences between these two kinds of markets, they are often used in
different ways. Due to the longer durations of their investments, capital markets are often used to
buy assets that the buying firm or investor hopes will appreciate in value over time so as to
generate capital gains, and are used to sell those assets once the firm or investor thinks the time is
right. Firms will often use them in order to raise long-term capital.
Money markets, on the other hand, are often used to general smaller amounts of capital or are
simply used by firms as a temporary repository for funds. Through regularly engaging with
money markets, companies and governments are able to maintain their desired level of liquidity
on a regular basis. Moreover, because of their short-term nature, money markets are often
considered to be safer investments than those made on the equities market. Due to the fact that
longer terms are generally associated with investing in capital markets, there is more time during
which the security in question may see improved or worsened performance. As such, equity and
debt securities are generally considered to be riskier investments than those made on the money
market.

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