What are Capital Markets?
In capital markets, equity-backed securities and long-term debt are both bought and sold. Major financial regulators, such as the U.S. Securities and Exchange Commission (SEC) are responsible for overseeing the capital markets. The regulators ensure that the investments made by savers are directed toward major companies and institutions that can facilitate the productive, long-term use of wealth, including substantial long-term investments.
The Modern Capital Market
Electronic trading systems are used almost exclusively in modern capital markets. The public can directly access some portion of the capital markets. However, most can only be tapped into by financial entities and the governments and treasury departments of countries. Investment banks, governmental departments, and stock exchanges are the primary hosts of the electronic trading systems located around the world. The highest concentration of capital markets is found in prominent financial meccas such as New York, London, and Hong Kong.
Capital Markets at Work
Looking back at the idea of how capital markets work in the sense of using the money to the advantage of investors, consider a corporate bond.
Corporate bonds are a debt instrument, with the issuing company receiving money from investors, to be used towards the company’s expenses. In our example, Company A issues 5-year bonds for $5,000. Investors purchase the bonds for the par value of $5,000, which goes directly to Company A.
With the bond purchase, investors receive the promise of full repayment of the principal or par value of the bond, plus interest. Interest rates on the 5-year bond depend on the issuing company and the market itself. Here, the interest rate on the 5-year bond is the prime rate plus 3% because of Company A’s perfect history of repayments.
The investor buying the bond receives regular interest payments over the life of the 5-year bond. The interest earned is the incentive for buying the bond. At the end of five years, Company A also returns the full $5,000 par value of the bond to the investor.
Capital markets are a staple of the global economy. They provide an arena in which investors looking to invest saved funding to earn greater wealth can do so. Not all companies or investments are created equal, and finding the right investment is dependent upon the investor and his individual wants and needs.
Thank you for reading CFI’s explanation of capital markets. CFI is the official provider of the Financial Modeling and Valuation Analyst (FMVA)™ certification program, designed to transform anyone into a world-class financial analyst.
To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below: