Capital market involve two parties on either end of a financial transaction. On one side, there are investors with capital who want to earn a return on their money. On the other, there are the companies, governments, or individuals who need to raise money. The capital market allow these two groups to come together so that both can meet their goals. Capital market is an essential part of many countries’ economies,making it possible for businesses to grow, for governments to provide essential services, and for individuals to invest and build their assets.
The bigger and more robust a country’s capital markets are, the more investment vehicles there typically are and the larger the potential investment capital that is available to fuel growth. At the same time, most capital market is regulated, by the government, the markets themselves, or by both.
The goal is to increase investor confidence, and, by extension, investor participation. Achieving it often depends on the perception that everyone has equal access to good information and the best prices.
What is capital market?
Capital market is the mechanism that allows the exchange of money between companies and investors, companies and banks, and investors and banks as each party seeks to raise capital or put capital to work.
While companies generally rely on their sales to keep their businesses going and on profits to underwrite new growth, there are times when a company might need a large amount of capital, perhaps to expand operations or cover operating losses. The capital market is a place to raise that money, letting companies offer ownership or promise repayment to investors in exchange for capital.
The capital market also enable individuals to buy a home, pay for college, or start a business. They can take a loan from a bank that lends its depositors’ money to borrowers in exchange for the promise of future repayment and interest.
It might help to think of the bank in this case as the investor, providing an individual with capital. In both cases, the availability of capital can contribute to economic growth. Expanding businesses typically create new jobs, putting more money into circulation.
Home buyers spend money to remodel and furnish their properties, creating or sustaining jobs. Of course, in any economy there are periods when investment capital dries up and the economy slows down — or when too much capital encourages inflation. Left unchecked by government or industry oversight, either situation could create serious problems.
The capital market offer companies many different ways to raise funds from many different investors, including individuals and large institutions. Usually, the first options an entrepreneur explores are private sources of funds. This part of the capital market may provide limited amounts of money, but allows companies to remain privately held and founders to retain control over their operations.
One private option is a corporate loan or line of credit from a bank. The process of qualifying is similar to what you might be familiar with if you’ve arranged a mortgage or large loan.
Based on a company’s financial history and prospects, a bank may determine that the company is likely to repay the loan plus interest and advances the company the money.
Another private option is to tap friends and family — private individuals who have some affiliation with the company or its officers and are willing to take investment risk for a share of future profits.
A third choice is venture capital, or the assets of private investors channeled through a professional investment firm that may add funds to a start-up or maturing company in exchange for a piece of ownership, some say over operations, and a share in the profits.
Public sources of funds
When companies need a greater amount of capital than their earnings or private sources can provide, they may turn to the public capital markets. In the U.S., that means going to Wall Street — shorthand for the financial markets. Issuing stock and bonds are the primary public ways of raising capital.
A company that issues stock sells shares of ownership in the company and becomes publicly held. That means the company has a fiscal responsibility to its shareholders, who have a vote in how the company is run and a right to benefit from the company’s success.
Once a company is publicly held it can also issue bonds to borrow money from investors, taking on the responsibility to repay the capital at some point in the future and pay interest for its use. Public sources of funds in the capital markets generally involve far greater sums than private sources. But using this money means that a company takes on a number of new responsibilities in exchange for the cash infusion.
When companies are raising funds:
There are benefits to using a combination of methods. A company might take a loan when starting up, or work with venture capitalists that invest in the company. Several years later they may go public by issuing stock to expand into new markets, and then issue bonds at some time after that to cover the cost of upgrading equipment.
The availability of several methods to raise funds is appealing to companies because it means they can continue to tap new sources of money over time. And by choosing several ways to raise funds, it’s possible to balance the advantages and disadvantages of each method.
For example, a publicly held company may issue bonds to raise additional funds because issuing more stock would dilute the value of existing stock, upsetting current shareholders.
Companies can also look to international capital market. Some countries may offer better opportunities for raising capital than others, since there may be more potential investors in one country than in another.
For example, a companies in a small or developing nation might face a limited domestic capital market, so it could choose to offer shares to the much larger pool of investors through American Depositary Receipts (ADRs) traded in the United States, or Global Depositary Receipts (GDRs) traded in markets around the world.
On the other hand, a European company might raise capital internationally by issuing bonds in a country with lower interest rates than it might have to pay at home, reducing the cost of raising the capital.