Capital Markets: What They Are and How They Work

What are capital markets?

Capital markets are venues—physical or electronic—where entities that need funds sell financial instruments to investors who have capital to deploy. Common capital markets include the stock market (equities), the bond market (debt securities), and related markets for currencies and commodities. Their primary purpose is to channel savings into productive uses, such as business expansion, infrastructure, and consumer lending.

How capital markets function

Participants
* Suppliers of capital: households (savings), pension funds, insurance companies, mutual funds, banks, and other institutional investors.
* Users of capital: corporations, governments, and individuals needing funding for operations, growth, projects, or purchases.

Key instruments
* Equities: ownership shares in a company (stocks).
* Debt securities: interest-bearing obligations (bonds) issued by governments or corporations.

Market venues and centers
* Trading occurs electronically and in physical exchanges concentrated in financial hubs like New York, London, Singapore, and Hong Kong.
* Capital markets facilitate price discovery, liquidity, risk transfer, and efficient allocation of resources across the economy.

Primary vs. secondary markets

Primary market
* Where new securities are issued and sold for the first time (e.g., an initial public offering, or IPO).
* Issuers raise fresh capital; transactions involve the company (or government) directly.
* Issuance typically involves underwriters who help set terms, prepare a prospectus, and market the offering (roadshows).
* Subject to regulatory approval and disclosure requirements; access is often focused on large institutional investors.

Secondary market
* Where existing securities are traded among investors after the initial issuance.
* Issuers do not receive proceeds from secondary trades.
* Includes auction-style exchanges (e.g., New York Stock Exchange) and dealer markets that operate through electronic networks (e.g., Nasdaq).
* Provides liquidity and continuous price formation, enabling investors to buy and sell holdings.

How capital markets differ from financial markets

“Financial markets” is a broader term that covers all venues where financial assets and contracts are exchanged (including derivatives, money markets, and foreign exchange). Capital markets are a subset focused on longer-term funding instruments—primarily equities and bonds—used to raise capital for investment and growth.

How firms raise capital

• Equity: private placements (angel investors, venture capital) or public offerings (IPOs) to list shares on exchanges.
• Debt: bank loans, corporate bonds, or other fixed-income instruments sold to investors in capital markets.

Why capital markets matter

• Enable efficient transfer of funds from savers to borrowers.
• Support corporate growth, public infrastructure, and consumer financing.
• Provide liquidity, price discovery, and risk management tools for investors and issuers.

Key takeaways

• Capital markets connect suppliers of funds (investors) with users of funds (companies, governments, individuals).
• They include primary markets (new issues that raise capital) and secondary markets (trading of existing securities).
• Equities and bonds are the main instruments; exchanges and electronic networks provide liquidity and price discovery.
• Well-functioning capital markets are essential for economic growth and efficient allocation of resources.