Just like any other market, capital markets are realms where there are sellers, buyers, and transactions going on. It is just that the products are different types of capitals.
Imagine a place where you can buy shares of companies, bonds, contracts, and plenty of other securities according to your taste (or risk appetite), but instead of consuming these products, you use them to generate more money and after a certain period you can sell them to other interested investors. Such a place is called a capital market.
It is believed that the 17th-century Dutch Republic was the birthplace of a fully-fledged capital market as it is known today. The first stock shares traded belonged to the Dutch East India Company which established Amsterdam Stock Exchange to have a place where companies could generate income by offering their shares to investors. Today, there are two primary types of capital markets as well as alternative types that you can read about below.
Types of Capital Markets
Types of capital markets depend on types of securities that are exchanged, primarily equities and long-term debts and transaction parties involved. Both of these entail different risks for investors and different obligations for users – be it companies or governments.
These types of securities are exchanged on stock markets and give investors ownership of a company. It means sharing the future profits of that company and is generally riskier because of the uncertain future of businesses. The capital earners (or security issuers, i.e. companies, governments) are not obliged to pay back the investment made in them.
Long-term Debt Securities
Under debt securities in the context of capital markets, what is meant is usually bonds being bought from companies which are like borrowing money and paying it back along with an interest rate. This type of investment in the capital market is considered less risky since it guarantees a fixed income in the form of an interest rate in addition to getting back your investment.
So far, we were implying publicly traded companies and therefore capital markets where investors are individuals with moderate-level capital, but some companies can access money via other ways including venture capital or private equity funding. In these cases, money flows from high-net-worth individuals, investment funds, banks, or other types of financial institutions.
How Capital Markets Work
Transactions in capital markets can take place in either primary markets or secondary markets. The former is when an investor buys the security of a company directly from the issuing company itself. This is usually when a start-up wants to expand its business and needs capital and gets itself listed in a stock market (called Initial Public Offerings – IPOs).
Banks, financial analysts, and accountants are intermediaries who ensure that this process – ownership transfer is legal and they attract an adequate number of investors to attract capital. After an investment has taken place, security in the form of stock or equity is issued which then can be sold to other investors without the involvement of the companies in a secondary market.
All these processes may take place in a regulated stock exchange such as New York Stock Exchange, or through an unregulated over-the-counter (OTC) marketplace with the intermediation of brokers.
Capital Markets Outlook
During the economic slowdown caused by the pandemic of 2020, global capital markets reached new heights in terms of record levels of mergers and acquisitions, security issuances, and companies going public rapidly increasing. This strengthened the position of capital markets as a backbone of the global economy enabling huge amounts of money to be transferred from investors to entities in need of capital.
The global nature of capital markets means local companies can easily have access to international investors and fund their expansion by issuing shares, and bonds and using other financial instruments. A number of such companies getting publicly listed for the first time, in other words, the number of IPOs in 2021 was reported to be more than 1800. This represented $360 billion – the record high in history despite the expensiveness and complexity of IPO processes.
The year 2022 is expected to record even higher levels of activity in capital markets. An important driver of increased money flows in capital markets is the environment, social, and governance (ESG) agenda. This is an increasingly important consideration for investors trying to make an impact by investing in sustainably conscious projects and companies. This factor is even more influential thanks to major regulatory oversight put in place such as European Union (EU) Sustainable Finance Disclosure Regulation (SFDR).
Capital markets are the foundations of a global capitalist economy that provide a place for investors to invest their excess capital in exchange for returns. This is where businesses needing to expand operations or governments needing capital to invest in infrastructure and other development areas can raise it. Capital markets are one way how a market-based economy grows.
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