Capital markets definition
/What are Capital Markets?
A capital market is an organized market in which both individuals and business entities buy and sell debt securities and equity securities. It is designed to be an efficient way to enter into purchase and sale transactions. This market is a key source of funds for an entity whose securities are permitted by a regulatory authority to be traded, since it can readily sell its debt obligations and equity to investors. Governments also use capital markets to raise funds, typically through the issuance of long-term bonds. Governments do not issue shares, and so cannot issue equity securities.
Capital markets are highly interconnected, so a disturbance in a capital market on the other side of the globe will likely impact trading in markets located in other countries.
What is the Role of Financial Markets?
There are several types of capital markets, but they are similar in the types of roles they provide for market users. Here are some of the key roles of these markets:
Price setting. Given the large numbers of participants in capital markets, it is easy to determine the prices at which buyers are willing to make purchases, and sellers are willing to sell.
Asset valuation. The price setting role just noted is useful for determining the prices of assets held by an entity. For example, a business might have invested $1 million in a security, but the price setting role of the capital markets indicates that the investment is now worth only $800,000.
Arbitrage opportunities. An excellent role for capital markets is to spot pricing anomalies and profit from them. This means that prices across geographic regions tend to move toward a uniform level in all markets, until there are no arbitrage opportunities left for anyone to exploit.
Capital sourcing. A business in need of funds can sell shares or issue debt instruments on a capital market. The prices at which the shares or debt can be sold should be optimized, if there are many investors participating in the market.
Cash investments. Capital markets are a good place in which to park excess cash, in order to generate a return. These investments could range from overnight investments to ones that an investor might have no intention of selling for a long period of time.
Related AccountingTools Courses
Guide to the Financial Markets
Primary and Secondary Market Activity
A capital market is intended to be for the issuance and trading of long-term securities. When a publicly held company sells its securities in the capital markets, this is referred to as primary market activity. The subsequent trading of company securities between investors is known as secondary market activity. Short-term securities are traded elsewhere, such as in the money market.
Examples of Capital Markets
Examples of highly organized capital markets are the New York Stock Exchange, American Stock Exchange, London Stock Exchange, and NASDAQ. Securities can also be traded "over the counter," rather than on an organized exchange. These securities are usually issued by entities whose business fundamentals (such as revenue, capitalization, and profitability) do not meet the minimum standards of a formal exchange, which forces investors to use other avenues to trade the securities.
Regulation of Capital Markets
The Securities and Exchange Commission (SEC) is an example of a federal-level agency that regulates the reporting of information by any entity that wishes to issue securities in a capital market, or have its securities traded in a capital market.