The capital market revolves around capital. Capital is more or less another word for money — usually money that businesses need to produce the goods or services they sell. When a business needs to raise capital, it uses common capital markets like the stock or bond market to borrow the necessary funds from investors and lenders.
Lenders and investors get something in return, such as stock in the company or the ability to earn interest on the loans they extend to the company. In essence, capital markets are where borrowers and lenders meet to exchange securities. Learn more about how capital markets work to better understand this important element of the economy and our finance industry as a whole.
How Do Capital Markets Work?
Capital markets are one of the foundations of free-market economies and an important component of generating wealth. Think of them as a place where wealth is traded, potentially to the benefit of both parties. Say, for instance, that company ABC is a mid-sized company that’s ready to take things to the next level but doesn’t have the capital to do it.
By exchanging shares of the company on the capital market, ABC could raise the money it needs to buy new equipment, open new locations or otherwise expand. This could help it grow faster and benefit investors at the same time.
Components of the Capital Market
Within the capital market, there are two categories, or subgenres: primary markets and secondary markets. The primary market is where investors can buy securities directly from a company itself. Buying on the primary market usually takes place when a company first goes public by releasing its initial shares on the stock market, and the investors at this stage are usually larger, institutional investors like hedge and mutual funds.
The secondary market is where securities are re-sold. Say, for instance, that a hedge fund purchased shares of company ABC. If the hedge fund then wanted to sell or trade those shares, it could do so on a secondary market, such as the New York Stock Exchange (NYSE) and Nasdaq.
Types of Capital Markets
There are several types of capital markets. Common examples include:
- Public Markets: As mentioned, the stock market is a common example of the capital market. It’s where public companies sell securities to raise capital.
- Corporate Finance: This is a type of capital market that deals with not only financing but also investing and structuring decisions.
- Investment Banks, Equity Firms and Venture Capital Firms: These are private groups where private companies turn to raise capital, as opposed to public exchanges like the stock market.
What Are Capital Market Instruments?
To put things simply, capital market instruments are, in essence, different ways to buy and sell debt. Examples of different capital market instruments include stocks, bonds and other securities.
The main thing to understand is that capital market instruments describe various ways that borrowers, whether they’re public companies or individuals, raise capital funding. These instruments arer also used to outline the terms of what the lender will get in return, whether that’s shares of the company or interest.
Types of Capital Market Instruments
Capital market instruments can take a variety of forms, such as:
- Sovereign, state or municipal bonds
- Debenture, industrial loans or corporate bonds
- Equities, or common stocks
- Preference shares
- Mortgage-backed securities (MBS)
- Asset-backed securities (ABS)
- Exchange-traded funds or commodities
- Foreign exchange (Forex) market currencies
Capital Market vs. Money Market
A common question concerning the capital market is whether it’s the same thing as the money market. The answer? Not quite, although the two are related. The capital market and money market are two different components of what’s known overall as the financial market.
The capital market aims to raise long-term capital that’s used for business expansion, increasing revenues and similar objectives. The money market, on the other hand, is more focused on raising short-term capital. Money markets are where businesses and sometimes governments go to raise the capital they only need to borrow for a short time at reasonable interest rates.
Investors in money markets range from individuals to banks or other companies that want to make a short-term investment, usually for a period of a year or less. While this kind of investment tends to be a much safer play than those performed on the capital market, it also tends to yield much more modest rewards.
Tools Used in the Capital Market
As mentioned above, the main tools used in the capital market consist of stocks and bonds, treasury bills, foreign exchange, fixed deposits and debentures, among others. The money market, in contrast, uses a different set of instruments to secure short-term assets that are usually used to cover routine expenses rather than large-scale projects or expansions. These tools include things like:
- Collateral loans
- Bills of exchange
While the capital market is a preferred way for companies to raise capital, the money market is often used by the Federal Reserve and commercial banks.
How to Invest in the Capital Market
These days, most investments in the capital market can be executed online. Trading platforms like TD Ameritrade, Webull and even Robinhood allow individual investors to invest in stocks, exchange-traded funds and bonds. You can also purchase bonds directly from the U.S. government at Treasury Direct.
Forex trading can also be done online, as can money market investing. If you’re a beginner or are unsure which path to take, it’s wise to consult with a financial adviser. There’s currently a vast array of avenues to head down when investing in the capital market. The key is to do your research and find out which one is best for you based on your short- and long-term financial goals.