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A capital market is a
financial market A financial market is a market (economics), market in which people trade financial Security (finance), securities and derivative (finance), derivatives at low transaction costs. Some of the securities include stocks and Bond (finance), bonds, ...
in which long-term
debt Debt is an obligation that requires one party, the debtor, to pay money or other agreed-upon value to another party, the creditor. Debt is a deferred payment, or series of payments, which differentiates it from an immediate purchase. The de ...
(over a year) or equity-backed
securities A security is a tradable financial asset. The term commonly refers to any form of financial instrument, but its legal definition varies by jurisdiction. In some countries and languages people commonly use the term "security" to refer to any for ...
are bought and sold, in contrast to a
money market The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less. As Security (finance)#Debt, short-term securities became a commodity, the mone ...
where short-term debt is bought and sold. Capital markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments.
Financial regulator Financial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the stability and integrity of the financial system. This may be handled ...
s like Securities and Exchange Board of India (SEBI),
Bank of England The Bank of England is the central bank of the United Kingdom and the model on which most modern central banks have been based. Established in 1694 to act as the Kingdom of England, English Government's banker, and still one of the bankers fo ...
(BoE) and the U.S. Securities and Exchange Commission (SEC) oversee capital markets to protect investors against fraud, among other duties. Transactions on capital markets are generally managed by entities within the financial sector or the treasury departments of governments and corporations, but some can be accessed directly by the public. As an example, in the United States, any American citizen with an internet connection can create an account with
TreasuryDirect TreasuryDirect is a website run by the Bureau of the Fiscal Service under the United States Department of the Treasury that allows US individual investors to purchase United States Treasury security, treasury securities, such as savings bonds ...
and use it to buy bonds in the primary market, though sales to individuals form only a tiny fraction of the total volume of bonds sold. Various private companies provide browser-based platforms that allow individuals to buy shares and sometimes even bonds in the secondary markets. There are many thousands of such systems, most serving only small parts of the overall capital markets. Entities hosting the systems include stock exchanges, investment banks, and government departments. Physically, the systems are hosted all over the world, though they tend to be concentrated in
financial centre A financial centre (British English, BE), financial center (American English, AE), or financial hub, is a location with a concentration of Global financial system#Participants, participants in banking, asset management, insurance or financial ...
s like London, New York, and Hong Kong.


Definition

A capital market can be either a
primary market :''"Primary market" may also refer to Art valuation#Primary and secondary markets, a market in art valuation.'' The primary market is the part of the capital market that deals with the issuance and sale of securities to purchasers directly by the i ...
or a
secondary market The secondary market, also called the aftermarket and follow on public offering, is the financial markets, financial market in which previously issued financial instruments such as stock, Bond (finance), bonds, option (finance), options, and Fut ...
. In a primary market, new stock or bond issues are sold to investors, often via a mechanism known as
underwriting Underwriting (UW) services are provided by some large financial institutions, such as banks, insurance companies and investment houses, whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liabil ...
. The main entities seeking to raise long-term funds on the primary capital markets are governments (which may be municipal, local or national) and business enterprises (companies). Governments issue only bonds, whereas companies often issue both equity and bonds. The main entities purchasing the bonds or stock include
pension fund A pension fund, also known as a superannuation fund in some countries, is any plan, fund, or scheme which provides pension, retirement income. Pension funds typically have large amounts of money to invest and are the major investors in listed a ...
s,
hedge fund A hedge fund is a pooled investment fund that trades in relatively Market liquidity, liquid assets and is able to make extensive use of more complex trader (finance), trading, portfolio (finance), portfolio-construction, and risk management techn ...
s,
sovereign wealth fund A sovereign wealth fund (SWF), sovereign investment fund, or social wealth fund is a state-owned investment fund that invests in real and financial assets such as stocks, Bond (finance), bonds, real estate, precious metals, or in alternative inve ...
s, and less commonly wealthy individuals and investment banks trading on their own behalf. In the secondary market, existing securities are sold and bought among investors or traders, usually on an exchange,
over-the-counter Over-the-counter (OTC) drugs are medicines sold directly to a consumer without a requirement for a prescription from a healthcare professional, as opposed to prescription drugs, which may be supplied only to consumers possessing a valid pres ...
, or elsewhere. The existence of secondary markets increases the willingness of investors in primary markets, as they know they are likely to be able to swiftly cash out their investments if the need arises.''Privatization and Capital Market Development: Strategies to Promote Economic Growth'', Michael McLindon (1996) A second important division falls between the
stock market A stock market, equity market, or share market is the aggregation of buyers and sellers of stocks (also called shares), which represent ownership claims on businesses; these may include ''securities'' listed on a public stock exchange, as ...
s (for equity securities, also known as shares, where investors acquire ownership of companies) and the
bond market The bond market (also debt market or credit market) is a financial market where participants can issue new debt, known as the primary market, or buy and sell debt security (finance), securities, known as the secondary market. This is usually in th ...
s (where investors become creditors).


Versus money markets

The
money market The money market is a component of the economy that provides short-term funds. The money market deals in short-term loans, generally for a period of a year or less. As Security (finance)#Debt, short-term securities became a commodity, the mone ...
s are used for the raising of short-term finance, sometimes for loans that are expected to be paid back as early as overnight. In contrast, the "capital markets" are used for the raising of long-term finance, such as the purchase of shares/equities, or for loans that are not expected to be fully paid back for at least a year. Funds borrowed from money markets are typically used for general operating expenses, to provide liquid assets for brief periods. For example, a company may have inbound payments from customers that have not yet cleared, but need immediate cash to pay its employees. When a company borrows from the primary capital markets, often the purpose is to invest in additional physical
capital good The economic concept of a capital good (also called complex product systems (CoPS),H. Rush, "Managing innovation in complex product systems (CoPS)," IEE Colloquium on EPSRC Technology Management Initiative (Engineering & Physical Sciences Researc ...
s, which will be used to help increase its income. It can take many months or years before the investment generates sufficient return to pay back its cost, and hence the finance is long term. Together, money markets and capital markets form the
financial market A financial market is a market (economics), market in which people trade financial Security (finance), securities and derivative (finance), derivatives at low transaction costs. Some of the securities include stocks and Bond (finance), bonds, ...
s, as the term is narrowly understood. The capital market is concerned with long-term finance. In the widest sense, it consists of a series of channels through which the savings of the community are made available for industrial and commercial enterprises and public authorities.


Capital market versus bank loans

Regular bank lending is not usually classed as a capital market transaction, even when loans are extended for a period longer than a year. First, regular bank loans are not securitized (i.e. they do not take the form of a resaleable security like a share or bond that can be traded on the markets). Second, lending from banks is more heavily regulated than capital market lending. Third, bank depositors tend to be more risk-averse than capital market investors. These three differences all act to limit institutional lending as a source of finance. Two additional differences, this time favoring lending by banks, are that banks are more accessible for small and medium-sized companies, and that they have the ability to create money as they lend. In the 20th century, most company finance apart from share issues was raised by bank loans. But since about 1980 there has been an ongoing trend for disintermediation, where large and creditworthy companies have found they effectively have to pay out less interest if they borrow directly from capital markets rather than from banks. The tendency for companies to borrow from capital markets instead of banks has been especially strong in the United States. According to the ''
Financial Times The ''Financial Times'' (''FT'') is a British daily newspaper A newspaper is a Periodical literature, periodical publication containing written News, information about current events and is often typed in black ink with a white or gray ba ...
'', capital markets overtook bank lending as the leading source of long-term finance in 2009, which reflects the risk aversion and bank regulation in the wake of the
2008 financial crisis 8 (eight) is the natural number following 7 and preceding 9. In mathematics 8 is: * a composite number, its proper divisors being , , and . It is twice 4 or four times 2. * a power of two, being 2 (two cubed), and is the first number of the ...
. Compared to in the United States, companies in the
European Union The European Union (EU) is a supranational union, supranational political union, political and economic union of Member state of the European Union, member states that are located primarily in Europe, Europe. The union has a total area of ...
have a greater reliance on bank lending for funding. Efforts to enable companies to raise more funding through capital markets are being coordinated through the EU's Capital Markets Union initiative.


Examples


Government on primary markets

When a government wants to raise long-term finance it will often sell bonds in the capital markets. In the 20th and early 21st centuries, many governments would use
investment bank Investment is the dedication of money to purchase of an asset to attain an increase in value over a period of time. Investment requires a sacrifice of some present asset, such as time, money, or effort. In finance, the purpose of investing is ...
s to organize the sale of their bonds. The leading bank would underwrite the bonds, and would often head up a syndicate of brokers, some of whom might be based in other investment banks. The syndicate would then sell to various investors. For developing countries, a multilateral development bank would sometimes provide an additional layer of
underwriting Underwriting (UW) services are provided by some large financial institutions, such as banks, insurance companies and investment houses, whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liabil ...
, resulting in risk being shared between the investment bank(s), the multilateral organization, and the end investors. However, since 1997 it has been increasingly common for governments of the larger nations to bypass investment banks by making their bonds directly available for purchase online. Many governments now sell most of their bonds by computerized auction. Typically, large volumes are put up for sale in one go; a government may only hold a small number of auctions each year. Some governments will also sell a continuous stream of bonds through other channels. The biggest single seller of debt is the U.S. government; there are usually several transactions for such sales every second, which corresponds to the continuous updating of the U.S. real-time debt clock.


Company on primary markets

When a company wants to raise money for long-term investment, one of its first decisions is whether to do so by issuing bonds or shares. If it chooses shares, it avoids increasing its debt, and in some cases the new shareholders may also provide non-monetary help, such as expertise or useful contacts. On the other hand, a new issue of shares will dilute the ownership rights of the existing shareholders, and if they gain a controlling interest, the new shareholders may even replace senior managers. From an investor's point of view, shares offer the potential for higher returns and capital gains if the company does well. Conversely, bonds are safer if the company does poorly, as they are less prone to severe falls in price, and in the event of bankruptcy, bond owners may be paid something, while shareholders will receive nothing. When a company raises finance from the primary market, the process is more likely to involve face-to-face meetings than other capital market transactions. Whether they choose to issue bonds or shares, companies will typically enlist the services of an investment bank to mediate between themselves and the market. A team from the investment bank often meets with the company's senior managers to ensure their plans are sound. The bank then acts as an
underwriter Underwriting (UW) services are provided by some large financial institutions, such as banks, insurance companies and investment houses, whereby they guarantee payment in case of damage or financial loss and accept the financial risk for liabilit ...
, and will arrange for a network of brokers to sell the bonds or shares to investors. This second stage is usually done mostly through computerized systems, though brokers will often phone up their favored clients to advise them of the opportunity. Companies can avoid paying fees to investment banks by using a direct public offering, though this is not a common practice as it incurs other legal costs and can take up considerable management time.''An Introduction to International Capital Markets: Products, Strategies, Participants'' , Andrew M. Chisholm, (2009), Wiley, see esp Chapters 1, 4 & 8


Secondary market trading

Most capital market transactions take place on the secondary market. On the primary market, each security can be sold only once, and the process to create batches of new shares or bonds is often lengthy due to regulatory requirements. On the secondary markets, there is no limit to the number of times a security can be traded, and the process is usually very quick. Transactions on the secondary market do not directly raise finance, but they do make it easier for companies and governments to raise finance on the primary market, as investors know that if they want to get their money back quickly, they will usually be easily able to re-sell their securities. Sometimes, however, secondary capital market transactions can have a negative effect on the primary borrowers: for example, if a large proportion of investors try to sell their bonds, this can push up the yields for future issues from the same entity. An extreme example occurred shortly after
Bill Clinton William Jefferson Clinton (Birth name, né Blythe III; born August 19, 1946) is an American politician who served as the 42nd president of the United States from 1993 to 2001. He previously served as governor of Arkansas from 1979 to 1981 ...
began his first term as President of the United States; Clinton was forced to abandon some of the spending increases he had promised in his election campaign due to pressure from the bond markets . In the 21st century, several governments have tried to lock in as much as possible of their borrowing into long-dated bonds, so they are less vulnerable to pressure from the markets. Following the
financial crisis of 2007–08 Finance is the study and discipline of money, currency and capital assets. It is related to, but not synonymous with economics, the study of Production (economics), production, Distribution (economics), distribution, and Consumption (economics) ...
, the introduction of
quantitative easing Quantitative easing (QE) is a monetary policy action whereby a central bank purchases predetermined amounts of government bonds or other financial assets in order to stimulate economic activity. Quantitative easing is a novel form of monetary pol ...
further reduced the ability of private actors to push up the yields of government bonds, at least for countries with a
central bank A central bank, reserve bank, or monetary authority is an institution that manages the currency and monetary policy of a country or monetary union, and oversees their commercial bank, commercial banking system. In contrast to a commercial ba ...
able to engage in substantial
open market operation In macroeconomics, an open market operation (OMO) is an activity by a central bank to give (or take) liquidity in its currency to (or from) a bank or a group of banks. The central bank can either buy or sell government bonds (or other financial as ...
s. A variety of different players are active in the secondary markets. Individual investors account for a small proportion of trading, though their share has slightly increased; in the 20th century it was mostly only a few wealthy individuals who could afford an account with a broker, but accounts are now much cheaper and accessible over the internet. There are now numerous small traders who can buy and sell on the secondary markets using platforms provided by brokers which are accessible via web browsers. When such an individual trades on the capital markets, it will often involve a two-stage transaction. First they place an order with their broker, then the broker executes the trade. If the trade can be done on an exchange, the process will often be fully automated. If a dealer needs to manually intervene, this will often mean a larger fee. Traders in investment banks will often make deals on their bank's behalf, as well as executing trades for their clients. Investment banks will often have a division (or department) called "capital markets": staff in this division try to keep aware of the various opportunities in both the primary and secondary markets, and will advise major clients accordingly.
Pension A pension (, from Latin ''pensiō'', "payment") is a fund into which a sum of money is added during an employee's employment years and from which payments are drawn to support the person's retirement from work in the form of periodic payments ...
and
sovereign wealth fund A sovereign wealth fund (SWF), sovereign investment fund, or social wealth fund is a state-owned investment fund that invests in real and financial assets such as stocks, Bond (finance), bonds, real estate, precious metals, or in alternative inve ...
s tend to have the largest holdings, though they tend to buy only the highest grade (safest) types of bonds and shares, and some of them do not trade all that frequently. According to a 2012 ''Financial Times'' article, hedge funds are increasingly making most of the short-term trades in large sections of the capital market (like the UK and US stock exchanges), which is making it harder for them to maintain their historically high returns, as they are increasingly finding themselves trading with each other rather than with less sophisticated investors. There are several ways to invest in the secondary market without directly buying shares or bonds. A common method is to invest in
mutual fund A mutual fund is a professionally managed investment fund that pools money from many investors to purchase Security (finance), securities. The term is typically used in the United States, Canada, and India, while similar structures across the globe ...
s or
exchange-traded fund An exchange-traded fund (ETF) is a type of investment fund and exchange-traded product, i.e. they are traded on stock exchanges. ETFs are similar in many ways to mutual funds, except that ETFs are bought and sold from other owners throughout the d ...
s. It is also possible to buy and sell derivatives that are based on the secondary market; one of the most common type of these is contracts for difference – these can provide rapid profits, but can also cause buyers to lose more money than they originally invested.


Size

All figures given are in billions of US$ and are sourced to the IMF. There is no universally recognized standard for measuring all of these figures, so other estimates may vary. A
GDP Gross domestic product (GDP) is a money, monetary Measurement in economics, measure of the market value of all the final goods and services produced and sold (not resold) in a specific time period by countries. Due to its complex and subjec ...
column is included as a comparison.


Forecasting and analyses

A great deal of work goes into analysing capital markets and predicting their future movements. This includes academic study; work from within the financial industry for the purposes of making money and reducing risk; and work by governments and multilateral institutions for the purposes of regulation and understanding the impact of capital markets on the wider economy. Methods range from the gut instincts of experienced traders, to various forms of stochastic calculus and algorithms such as Stratonovich-Kalman-Bucy filtering algorithm.


Capital controls

Capital controls are measures imposed by a state's government aimed at managing capital account transactions – in other words, capital market transactions where one of the counter-parties involved is in a foreign country. Whereas domestic regulatory authorities try to ensure that capital market participants trade fairly with each other, and sometimes to ensure institutions like banks do not take excessive risks, capital controls aim to ensure that the
macroeconomic Macroeconomics (from the Greek prefix ''makro-'' meaning "large" + ''economics'') is a branch of economics dealing with performance, structure, behavior, and decision-making of an economy as a whole. For example, using interest rates, taxes, and ...
effects of the capital markets do not have a negative impact. Most advanced nations like to use capital controls sparingly if at all, as in theory allowing markets freedom is a win-win situation for all involved: investors are free to seek maximum returns, and countries can benefit from investments that will develop their industry and infrastructure. However, sometimes capital market transactions can have a net negative effect: for example, in a
financial crisis A financial crisis is any of a broad variety of situations in which some financial assets suddenly lose a large part of their nominal value. In the 19th and early 20th centuries, many financial crises were associated with Bank run#Systemic bankin ...
, there can be a mass withdrawal of capital, leaving a nation without sufficient
foreign-exchange reserves Foreign exchange reserves (also called forex reserves or FX reserves) are cash and other reserve assets such as gold reserve, gold held by a central bank or other monetary authority that are primarily available to balance of payment, balance pa ...
to pay for needed imports. On the other hand, if too much capital is flowing into a country, it can increase
inflation In economics, inflation is an increase in the general price level of goods and services in an economy. When the general price level rises, each unit of currency buys fewer goods and services; consequently, inflation corresponds to a reductio ...
and the value of the nation's currency, making its exports uncompetitive. Countries like
India India, officially the Republic of India (Hindi: ), is a country in South Asia. It is the List of countries and dependencies by area, seventh-largest country by area, the List of countries and dependencies by population, second-most populous ...
employ capital controls to ensure that their citizens' money is invested at home rather than abroad.


See also

*
Bank A bank is a financial institution that accepts deposits from the public and creates a demand deposit while simultaneously making loans. Lending activities can be directly performed by the bank or indirectly through capital markets. Beca ...
* Center for Audit Quality (CAQ) * Committee on Capital Markets Regulation (United States) *
Credit union A credit union, a type of financial institution similar to a commercial bank, is a member-owned nonprofit organization, nonprofit financial cooperative. Credit unions generally provide services to members similar to retail banks, including depo ...
*
Financial market A financial market is a market (economics), market in which people trade financial Security (finance), securities and derivative (finance), derivatives at low transaction costs. Some of the securities include stocks and Bond (finance), bonds, ...
*
Financial regulation Financial regulation is a form of regulation or supervision, which subjects financial institutions to certain requirements, restrictions and guidelines, aiming to maintain the stability and integrity of the financial system. This may be handled ...
*
Stock exchange A stock exchange, securities exchange, or bourse is an Exchange (organized market), exchange where stockbrokers and stock trader, traders can buy and sell security (finance), securities, such as share (finance), shares of stock, Bond (finance) ...
* Capital Markets Union


Notes


References

{{DEFAULTSORT:Capital Market Financial markets Financial services