“Capital markets” is a broad term for the markets in which buyers and sellers link up to exchange financial securities. Generally though, capital markets are the markets where investors can purchase equity securities, or stocks, and fixed-income securities, or bonds, from companies and government entities. In Canada, the Toronto Stock Exchange (TSX) represents the largest capital market in the country and the seventh-largest in the world with respect to market capitalization.
Capital markets can help your small business achieve financial success, or they can help your investments earn extra income. Your company can buy stocks or bonds as an investment, or investors can buy shares of your company to see a return on their investment.
What Do Capital Markets Do?
Capital markets play a critical role in the global financial system. Due to their functionality, they help create jobs, build businesses and infrastructure, help people buy homes and finance their educations, and enable workers to save for retirement. As a business owner, capital markets also let you invest money to help increase profits, hire more employees, and grow your company.
Your business needs money to function. Capital markets put you in touch with investors, either directly or indirectly, to obtain solid financial footing on which to grow. Equity markets allow companies to sell, issue, and trade stocks or shares between buyers and sellers. Fixed-income markets, also known as the debt or bond markets, allow companies, governments, and other public entities such as cities, universities, or hospitals, to raise money by issuing loans in the form of bonds. Bonds usually have fixed terms for the duration of the debt, hence the name fixed-income markets.
In the most basic sense, when you use the capital market to buy stock, you buy a piece of a company and then own that share. If you buy a bond, you effectively lend money to the organization that issued the bond and receive interest payments over time.
Primary and Secondary Markets
Capital markets consist mainly of primary markets and secondary markets. These are distinctly different, but equally important. In primary markets, governments and companies create and issue brand-new securities to sell to a first wave of buyers. Using stocks as an example, companies issue new shares through an underwriting process. The firm then sells shares through an initial public offering. Your company can use a primary market to set up a new business or expand your current one when you need investment capital.
Secondary markets enable companies to sell securities that were previously issued in a primary market to all market participants. Secondary markets, such as stock exchanges, are where the vast majority of capital market activity occurs on a daily basis. If your company is large enough and you feel it has enough interest for people to buy stock, you can take your business public on a stock exchange.
Third and Fourth Markets
Though not as large as primary or secondary markets, third and fourth markets also exist. Individual investors don’t use these markets because the transactions are so large, and for the most part don’t have any noticeable effect on individual investors. The third market consists of what are known as “over-the-counter” trades, which are trades done over computer networks that do not involve any sort of stock exchange. This market goes through broker-dealers and other financial institutions that trade directly with one another. Fourth market trades are done only by very large financial institutions, and these transactions also happen directly with one another.
If you want your company to buy controlling interest in another company, you might perform an over-the-counter trade. Or, you may simply buy shares of a company directly from that entity.
Financial intermediaries involved in capital markets link up the buyers and sellers. As a business owner, you deal with these intermediaries all the time. Deposit-taking institutions, such as banks, insurance companies, and pension funds, represent the most common forms of financial intermediaries. You make deposits into your bank accounts and invest in employee pension funds through a financial advisor. Banks, in turn, invest the money you give them when they buy stocks or bonds to increase the return on your investment. For your contribution, you get a portion of that return. Banks succeed because they have a larger collection of money to invest due to all of their customers who keep accounts.
Investment dealers and investment funds are also financial intermediaries who deal with the buying and selling of stock. You can talk to private investment fund managers if you want to to diversify your investments beyond a bank account. Certain government institutions may also sometimes serve as intermediaries, such as when they sell bonds to private citizens to fund specific initiatives.
All of these entities play important roles in capital markets to keep money flowing.
Banks take in money as deposits and lend out those deposits as loans, enabling vast amounts of economic growth in every industry. Banks also make loans to businesses like yours to help them with day-to-day operations. Insurance companies and pension funds allow for protecting capital, insuring your business from accidents and unexpected losses, and saving for retirement. Investment dealers and investment funds help facilitate buying and selling of stocks or funds of several stocks rolled into a convenient package known as a mutual fund. Government organizations set laws and regulate activity in capital markets. All of these institutions also play a major role in providing money for capital markets during the times when buyers cannot find sellers, or vice versa.
Characteristics of Capital Markets
Capital markets are extremely large. As of 2018, around $76 trillion of worldwide financial activity flows through capital markets, the largest of which help foster tens of trillions of dollars of equity. Large financial markets exist in New York, London, Toronto, Tokyo, and Shanghai. Canada’s most popular capital market is the Toronto Stock Exchange, where you can easily invest in numerous Canadian companies.
As a small business owner, you stand to benefit from capital markets. You can invest in your own industry or purchase a particular stock as a growth opportunity with plans to use the eventual gains on the business. As a seller of equity to investors, you can raise capital for your business to invest in equipment or hiring more help, offer employees the perk of using stock options to turn shares into cash, and help value your business by selling shares to investors who see that your company offers a good opportunity to see steady returns.
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