Fundamentals of Capital Markets

In this lesson, you’re expected to learn about:
– components of capital markets
– how capital markets work
– types of securities

Capital markets play an important role in helping drive job creation, innovation and financial security. They enable people to save for retirement, afford to buy homes, finance their education, grow their businesses, and they enable communities to get funding to provide necessary services.

There are many kinds of financial markets, addressing many kinds of needs.

In this lesson, we’ll focus on debt and equity markets. 

What are Capital Markets?

The purpose of capital markets is to match the demand for funds with the supply of funds. These markets fuel economic growth by allocating capital that can be used to create jobs, build infrastructure and finance innovative ideas.

Capital Markets are made up of Debt and Equity Markets
Components of Capital Markets

There are three main components of global capital markets:

1) Buyers 
Individuals and institutions that seek a return on funds they invest.

2) Sellers 
Individuals and institutions that seek to raise funds to meet their needs, or manage their risk.

3) Financial Intermediaries 
Financial institutions that identify and connect buyers’ and sellers’ needs in real time or over time, and help determine a market price so that transactions can occur and funds can be allocated efficiently.

How Do Capital Markets Work?

Global capital markets consist of primary and secondary markets.

Primary markets create new securities. In primary markets, governments and companies raise cash by selling newly issued securities to buyers.

Secondary markets enable the buying and selling of previously issued securities. Most of the activity in the capital markets takes place in these markets.

Who Buys and Sells?

A variety of buyers and sellers come to the capital markets with different needs and objectives.

Financial intermediaries play an important role in facilitating transactions in which there isn’t a ready seller to match with a buyer, or vice versa. Or when there are different characteristics of assets involved, such as different sizes.

In these cases, the intermediary acts as a market maker, using its own capital or holding the assets until a buyer or seller can be found. This enables the buyer or seller to transact at that moment, regardless of market conditions.

Buyers 

Buyers can be individual or institutional investors. They come to the capital markets with a variety of needs:

– to buy stocks or bonds in order to “put cash to work” by investing and earning a return, such as for generating income on savings.
– to buy stocks or bonds on order to gain or limit exposure to macroeconomic trends or types of companies.
– to reinvest proceeds from gains realized in other investments.

Sellers 

Sellers can also be individual or institutional investors. They come to the capital markets with a variety of needs and goals:

– to issue equity or debt to list on a public exchange, which can broaden ownership in a company, establish a market value for a company, and create a “currency” for acquisitions and investments.
– to realize gains on investments.
– to sell stocks or bonds in order to raise cash to reallocate into different investments.

Who are the Buyers and Sellers?

1) Entrepreneurs
2) Investors
3) Companies
4) Pension Funds / Endowments
5) Governments

Let’s look at each of these in more details.

1) Entrepreneurs 

In the start-up stage, an entrepreneur tends to raise funds from private sources, such as their own savings or borrowings, or that of friends and family members and co-founders. As the company grows, and needs greater amounts of capital, the entrepreneur can come to the capital markets to raise funds and potentially do an initial public offering (IPO). 

2) Investors

Investors can be individual or institutional investors. Individual investors buy and sell securities for their own account, such as to invest their savings to plan for retirement. Institutional investors, such as mutual funds or other asset managers, manage portfolios of assets to generate a return, often on the behalf of individual investors investing their savings.

3) Companies 

A company is ‘public’ if its stock is traded on a public stock exchange. Listing on a public stock exchange by issuing stock is a way to raise funds in the capital markets. Companies can also go to the capital markets to borrow money from investors in the form of bonds, for which investors receive interest payments from the company.

4) Pension Funds / Endowments 

A pension fund pays benefits based on contributions and investments from employers and employees. Endowments, funded by donations, are used to help fund a not for profit institution’s operations.

5) Governments 

Governments include central banks, federal agencies, municipalities, state-owned enterprises and sovereign wealth funds. The capital markets, in particular debt markets, are an important source of funds for these institutions to raise money for large projects. Sovereign wealth funds are investment funds owned by a country that invest to benefit that country’s economy and people.

How Large are Capital Markets?
* Newly Industrialized Asian Economies: Singapore, Hong Kong, Taiwan, South Korea
What do Capital Markets Power?

The money raised through the capital markets fuels economic growth by enabling the creation of jobs, the building of infrastructure and the funding of innovative ideas.

Start-ups tap the capital markets to “go public,” to grow their businesses and bring new products and services to the marketplace, from life-saving pharmaceuticals to time-saving technologies. State and local governments use the proceeds of municipal bonds to construct roads, schools, hospitals and other public facilities.

1) Funding Innovation and Growth 
Start-ups and mature companies use capital markets to fund growth, to attract new or a more diverse set of investors, to hedge their risk, or to generate a return on investment.

2) Funding the Needs of Communities 
Municipalities raise funds to build critical infrastructure, such as airports, bridges, roads and schools to support communities.

Types of Securities

The United States has the largest capital markets of any country in the world.

These are some of the major types of securities issued in U.S. capital markets:

1) Municipal Bonds 
Debt issued by local government agencies. Municipal bond issuers include states, cities, countries, and public utilities.

2) Asset-Backed Securities 
Securities backed by the collateral of underlying assets. Such assets can include auto loans, credit card debt, mortgages or a company’s accounts receivables.

3) Treasuries 
Debt issued by the US government. Treasuries are generally considered to be low-risk assets by investors because the federal government stands behind them with its taxing power to avoid default.

4) Corporate Debt 
Debt issued by a company. The interest paid is usually higher than Treasuries, because this debt is considered to carry more risk. The interest rate on corporate bonds is based on a company’s ability to pay.

5) Equity 
A security, such as stock, that represents an ownership interest in a company and a claim on the company’s assets and earnings.

[Optional] Capital Markets
Jim Rohn Sứ mệnh khởi nghiệp