The capital markets are global and operating around us all the time—whether we know it or not. In this article, we shed light on what capital markets are, how they operate, who participates in them, and how they impact our lives. This information is relevant for anyone who’s interested in learning more about the global financial landscape, whether you’re an industry professional, are studying it as part of your university coursework, or are simply curious about the systems operating around you.
What are the capital markets?
Definition of capital markets
The capital markets are where entities—investors, institutions, governments, and other participants—buy, sell, and trade long-term financial instruments. The global capital markets are made up of organized systems that allow for the movement said capital between those entities.
The role of capital markets in the economy
The role of capital markets in the economy is vital—they enable capital to move between investors and businesses that need funding to operate, grow, and make a profit. For folks not deeply ingrained in the day-to-day of the global financial landscape, the capital markets still matter. They provide a huge source of financing that fuels economies around the globe. In the US, the capital markets supply trillions of dollars in corporate debt and mortgage funding, per the Brookings Institution. They also provide investment opportunities for individuals and families, both directly and through mutual funds, 401(k)s, and pension funds. The health and profitability of banks, insurers, and other financial institutions—things many of us interact with regularly—are affected by the capital markets.
Which markets are included within the capital markets?
An umbrella term, the capital markets encompass a handful of markets, including:
- Bond markets
- Debt securities markets
- Derivative markets, including options, futures, and swaps
- Foreign exchanges
- Private markets, including venture capital, private equity, real assets, and other alternative asset classes
- Public stock markets, like the Nasdaq
How do the capital markets work?
The capital markets are at work when investments, securities, and other financial instruments are moving between suppliers and those who seek to acquire capital. Suppliers are often banks and investors with capital on hand to invest strategically. Those looking for capital within the context of this market are typically businesses, governments, and individuals. The public and private capital markets are made up of primary and secondary markets.
Primary markets vs. secondary markets
The primary markets are where stocks, bonds, and other securities are initially created and wherein shares become available for the first time. In the public stock markets, this often happens through an IPO—when a private company goes public and its shares become available to the general public. The secondary marketsare where existing securities are traded, often on popular exchanges like the London Stock Exchange. In VC and PE, the secondary markets provide investors with liquidity and the opportunity to realize value and return capital without a full exit.
It’s important to note that private and public markets both have primary and secondary markets, and they’re all part of the broader capital markets landscape.
In the context of the private markets, secondary markets involve transactions between individual shareholders—such as general partners or employees—who buy or sell shares in a private company between each other instead of from the company itself. For public markets, most trading takes place via secondary markets, including exchanges like Euronext and the New York Stock Exchange (NYSE).
General partners and founders often participate in the secondary markets, as they frequently have equity in private companies. Employees of privately held companies who receive equity in the form of stock options, restricted stocks, or performance shares are also involved in the secondary markets.
Public markets vs. private markets
Most people are more familiar with public markets than private markets, but activity in the private markets plays an important role in helping companies receive funding. To understand this lesser known, traditionally opaque space, it’s important to understand how the public and private markets differ.
The public markets: In the public markets, companies sell shares to institutional and retail investors who can then buy, sell, or trade these shares on a stock exchange. When someone invests in the stock market, they own a portion of the public company they’ve invested in. Often larger and more mature, public companies are heavily regulated by government organizations. To ensure they remain accountable to shareholders, these companies are also legally required to disclose information about their performance, which makes it easy to see their financials, revenue, and more.
The private markets: In the private markets, on the other hand, fast-growing companies that are not publicly traded give professional investors equity in exchange for the funding and mentoring they need to continue growing. These investors include venture capital firms, which invest in young companies (startups), and private equity firms, which invest in more established companies.
With the exception of extremely wealthy individuals, the general public cannot invest in this space. Because private companies do not answer to public shareholders, they are less heavily regulated. They do not have to disclose earnings reports or submit financial statements for auditing, which makes it hard for outsiders to find reliable, accurate information about them.
Different types of securities traded in the capital markets
Securities are fungible financial instruments that hold monetary value. They’re items or goods that can be exchanged because they’re identical and all carry the same value, such as a dollar bill in the US. Across the capital markets’ primary and secondary market ecosystems, a variety of securities are traded, including but not limited to:
- Equity securities: Shares of capital stock, including common and preferred stock
- Debt securities: Corporate bonds, certificates of deposits (CDs), and collateralized securities like collateralized debt obligations (CDOs) and collateralized mortgage obligations (CMOs)
- Hybrid securities: Equity warrants, convertible bonds, and preference shares
What is the difference between the capital markets and money markets?
Despite their similarity in name, capital markets and money markets are distinctly separate from one another. Generally intended for long-term investments of at least one year or more, the capital markets are a way for businesses to secure money from investors in return for partial ownership in their company.
Money markets are where short-term (less than one year) lending and borrowing occur and some institutional-grade debt-based financial instruments, like commercial paper and treasury bills, are traded. For instance, banks will lend large amounts of money to other banks, institutions, or governments within the money markets. Retail investors can also participate in money markets through money market mutual funds or exchange-traded funds (ETFs).
Together, the capital markets and money markets make up what are broadly known as the financial markets.
Conclusion
To summarize, the capital markets are where long-term financial instruments are bought, sold, and traded. They span public and private markets and include primary and secondary markets across both.
The entities who supply these financial instruments include banks and investors, and those looking for capital can be businesses, governments, and people. In this environment, longer-term investments provide businesses with the cash flow they need and investors with an equity stake in said company. To expand, the benefits of capital market moves include:
- For businesses: Raise capital for growth and expansion, finance mergers and acquisitions, and manage risk
- For investors: Generate ROI, diversify portfolios, and achieve financial goals
- For economies: Promote economic growth and development, create jobs, and improve innovation
A vital takeaway is how prolific the capital markets are—how they operate all around us every day, whether we know it or not. They underpin our economies, and many of the goods and services we rely on.
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