Table of Contents
Capital markets refers to the exchanges or platforms where individuals, institutions, governments, and other entities come together to buy and sell securities.
Well-known capital markets typically include the stock, bond, and commodities markets, and these days crypto markets as well.
Capital markets generally facilitate the trading of longer-term securities vs. money markets, where investors can buy short-term debt.
Capital markets today may or may not have specific geographical locations, as most capital markets conduct business electronically.
Key Points
• Capital markets refers to platforms that enable entities to sell securities to raise funds for various purposes, and where investors can buy those instruments.
• Examples of well-known capital markets include the stock market, bond market, commodities market, forex market, crypto market, and more.
• Capital markets can have physical locations in financial capitals such as Tokyo, London, or New York, but most securities trading is done electronically.
• Capital markets are a critical part of the global economy, as they make it possible for money to change hands with relative ease.
What Are Capital Markets?
Capital markets perform a key economic role. They bring together those who need to sell securities and those who wish to buy them — thereby facilitating the movement of capital around the world. Capital markets include a wide range of securities markets where funds can be traded between companies, governments, institutions, and individuals for myriad reasons (like investing online).
Established capital markets include stock and bond markets, commodities, and now many investors add crypto markets to the list. Capital markets and money markets are distinct, though: money markets are where short-term debt is traded.
Most capital markets are located in the world’s financial centers, such as London, New York, Singapore, and Hong Kong.
What Are the Types of Capital Markets?
The most common capital markets are stock markets, where investors exchange capital for equity stakes in a given company, and the bond market, where investors exchange capital for debt repayment contracts (bonds) from a company, government or other entity.
Stock markets are probably the most well-known of the capital markets. They are where companies go to acquire the capital they need to grow, and where investors go to buy stocks, and find opportunities for their capital to grow.
Recommended: Understanding the Stock Market
Bond markets operate differently. For one thing, the bond market doesn’t have a central exchange. Instead, they sell over the counter (OTC). And most of the people who trade in this OTC market are professional traders, such as pension funds, investment banks, hedge funds, and asset managers.
A bond is similar to an IOU, in that investors agree to lend capital to a government, company, or other bond issuer in exchange for regular interest payments over time, and a guarantee their principal will be repaid when the bond matures.
Stock and bond markets are one way to divide up the capital markets. But there are other securities such as convertible bonds, convertible preference shares and other alternative securities that companies sell to raise capital.
Primary Market vs. Secondary Market
Capital markets are commonly divided into primary and secondary markets. The primary markets are where issuers sell “new” securities, and where investors buy them.
The other side of the capital markets are the secondary markets. This is where investors buy and sell the securities that have already been issued, often through a self-directed investing account.
Capital Markets vs. Financial Markets vs. Money Markets
Financial markets are a broader category that include both capital markets and money markets. People sometimes use all three terms interchangeably, but there are some distinctions.
Financial Markets
The term financial markets generally refers to any venue in which individuals and institutions trade any financial asset, including stocks, bonds, currencies, derivatives, commodities, and alternative investments, including cryptocurrency.
Capital Markets
Capital markets specifically refer to the places where companies and other entities go to raise capital. Some distinguish capital markets as the segment where investors can invest in longer-term securities, versus the short-term instruments available through money markets.
Money Markets
Capital markets are also distinct from money markets in that the money market is where investors trade short-term debt, generally less than one year. Money markets support entities that need the return from short-term debt instruments.
The key distinction between money markets and capital markets are the types of securities traded, their risk level, and duration.
Money market instruments are generally fixed-income securities, and as such can be considered lower risk than other securities traded in the capital markets.
Recommended: Bonds vs Stocks: Key Differences for Investors
Capital Markets vs. Other Funding Sources
When a company, government, or another entity needs to raise money, they have a few options. They can borrow money from a bank, or another institution. And a private company can even sell a stake to a private equity investor, a venture capital firm, or accept funding from an angel investor.
So what do the capital markets offer?
If a company wants to access large-scale funding from the capital markets, it can issue stocks or bonds via these public channels. To issue stocks to sell to the institutions that offer funding through the capital markets, the company will have to conduct an initial public offering, or IPO.
IPOs and Capital Markets
Many companies will choose to conduct an IPO to raise capital in amounts that simply aren’t available through private investors. The public capital market creates the opportunity for millions of investors to buy stakes in the company.
A company will usually consider an IPO when it has grown in size and matured as an organization. From a size perspective, one common time to consider an IPO is when a unicorn company has reached a valuation of $1 billion, though many companies go public before this point.
For many companies, the day of its IPO represents the beginning of a new stage of growth. In addition to the funds raised in an IPO, the credibility and transparency of being a publicly traded company can make it easier and less expensive to borrow money in the future.
Bond Issuance and Capital Markets
To access public funding through a bond issue, a company or another entity will start by discussing its need for capital with an investment bank or banks, which will act as the underwriter. In some cases, an entity may issue bonds directly, without using an underwriter.
If the bond issuer doesn’t have a rating from a bond-rating agency, the bank will help the borrower get in touch with the right rating agencies.
Once the terms of the bond are agreed upon, and the rating assigned to it, the bank sets up meetings with institutional investors. If they respond positively, then the bonds go to the investors who agreed to buy it over the course of the meetings leading up to the issuance date.
The Takeaway
The term capital markets encompasses the in-person and electronic exchanges where companies, governments, institutions, and other entities go to obtain capital from investors.
While the term financial markets is often used to indicate the means by which all types of securities and investment are traded, capital markets tends to refer to the platforms that facilitate the trading of equities and longer-term debt instruments.
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FAQ
What are capital markets in simple terms?
Capital markets bring together companies and other entities that need capital for various purposes, and investors who are willing to buy the securities they offer.
What is the capital market vs the stock market?
The stock market is an important subset of capital markets. It’s where companies that issue shares of their stock can find willing investors.
Is the crypto market a type of capital market?
Yes, the crypto market, where various cryptocurrencies are bought and sold, is increasingly aligned with the functioning of capital markets.
Photo credit: iStock/Ivan Pantic
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