Understanding Capital Markets
Essentially, capital is wealth, usually in the form of money or property. Capital markets exist when two groups interact: those who are seeking capital and those who have capital to provide. The capital seekers are the businesses and government who want to finance their projects and enterprises by borrowing or selling equity stakes. The capital providers are the people and institutions, who are willing to lend or buy, expecting to realize a profit.
A CAPITAL IDEA
Investment capital is wealth that you put to work. You might invest your capital in business enterprises of your own. But there’s another way to achieve the same goal: Let someone else do the investing for you.
By participating in the stock and bond markets, which are the pillars of the capital by investing in the equity or debt of issue that you believe have a viable plan for using that capital. Because so many investors participate in the capital markets, they make it possible for enterprise to raise substantial sums-enough to carry out much larger projects than might be possible otherwise.
The amounts they raise allow businesses to innovate and expand, create new products, reach new customers, improve processes, and explore new ideas. They allow governments to carry out projects that serve the public –building roads and firehouses, training armies, or feeding the poor, for example.
All of these things could be more difficult-perhaps even impossible-to achieve without the financing provided by the capital marketplace.
GOING TO MARKET
Sometimes investors buy and sell stocks and bonds in literal marketplaces-such as traditional exchange trading floors where trading deals are stuck. But many capital market transactions are handled through telephone orders or electronic trading systems that have no central location. As more and more of the business of the capital markets is conducted this way, the concept of a market as face-to-face meeting place has faded, replaced by the idea of the capital markets as a general economic system.
PRIMARY AND SECONDARY
There are actually two levels of the capital markets in which investors participate: the primary markets and the secondary markets.
Business and government raise capital in primary markets, selling stocks and bonds to investors and collecting the cash. In secondary markets, investors buy and sell the stocks and bonds among themselves-or more precisely, through intermediaries. While the money raised in secondary sales doesn’t go to stock or bond issuers, it does create an incentive for investors to commit capital to investments in the first place.
OTHER PRODUCT, OTHER MARKETS
The capital markets aren’t the only markets around. To have a market, all you need are buyers and sellers-sometimes interacting in a physical space, such as a farmer’s market or a shopping mall, and sometimes in an electronic environment.
There are a variety of financial markets in the economy, trading a range of financial instruments. For example, currency markets set the values of world currencies relative to each other. In this case, market participants exchange one currency for another either to meet their financial obligations or to speculate on how the values will change. Similarly, the commodity futures market, among other’ bring together buyers and sellers who have specific financial interests
Many investors put money into securities hoping that prices will rise, allowing them to sell at a profit. But they also want to know they’ll be able to liquidate their investment, or sell them for cash at any time, in case they need the money immediately. Without robust secondary markets, there would be less participation in the primary-and therefore less capital could be raised. (of course, there are also other reason why investors may stay away from primary markets.)
THE PRICE IS RIGHT
One of the most notable features of both the primary and secondary financial markets is that price are set according to the forces of supply and demand through the trading decisions of buyers and sellers. When buyers dominate the markets, prices rise. When sellers dominate, prices drop.
You’ve undoubtedly experienced the dynamics of market pricing if you’ve ever haggled with a vendor. If the two of you settle on a price at which you’re willing to buy and the vendor is willing to sell, you’ve set a market price for the item. But if someone comes along who is willing to pay more than you are, then the vendor may sell at the higher price.
If there are a limited number of items and many buyers are interested, the price goes up as the buyers outbid each other. But if more sellers arrive, offering the same item and increasing the supply, the price goes down. So the monetary value of a market item is what someone is willing to pay for it.
In fact, price often serves as an economic thermometer, measuring supply and demand. One of the problems in command economics, in which prices are set by a central government authority instead of the marketplace, is that, without changing prices to clue them in, producers don’t know when to adjust supplies to meet demands, resulting in chronic overstocks and shortages.
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