Capital Markets Overview

Study Notes

Capital Markets

Capital markets facilitate the flow of funds from savers to borrowers/investors who require long-term finance.
Capital markets offer both short-term and long-term funding options.
Key instruments traded in the capital market include equity, credit, insurance, foreign exchange, hybrid, and derivative instruments.
The key functions of the capital market include:
- Facilitating the trade-off between risk and return for investors.
- Promoting the dispersion of business ownership.
- Contributing to the development of a country's capital formation.
- Creating liquidity for investors in financial instruments.

Primary Market

The primary market is the initial point where companies issue securities to raise capital.
This market focuses on new issues of shares, debentures, and other securities.
Funds flow directly from savers to borrowers (typically companies).
The primary market is critical for capital formation, allowing companies to finance expansion, modernization, and new business ventures.
Key methods for raising capital in the primary market include:
- Public Issue: Open offering of securities to the public.
- Offer for Sale: Securities sold by an intermediary on behalf of the issuing company.
- Private Placement: Securities issued directly to a limited number of investors.
- Right Issue: Existing shareholders have preferential rights to purchase new shares.
- Electronic Initial Public Offer (e-IPO): Digital platform for issuing securities.

Secondary Market

The secondary market involves the trading of previously issued securities between investors.
Transactions commonly occur through stock exchanges, facilitating the purchase and sale of shares, bonds, and other securities.
The secondary market promotes liquidity by allowing investors to readily sell their existing holdings.
This liquidity encourages new investments in the primary market.

Capital Market Risks

High risks are inherent in long-term investments due to market volatility.
The text highlights risks associated with two key capital market segments – stock and bond markets:

Stock Market Risks

Stock prices are notoriously volatile, unlike the relatively stable returns of bank deposits or government bonds.
Efficient Market Hypothesis: Proposes that all price movements are random, suggesting that it is difficult to consistently outperform the market through stock trading.
However, research indicates a specific trend in stock market prices over time, acknowledging psychological factors that influence market sentiment.
Market behavior can be irrational, driven by news, rumors, and mass panic, affecting stock prices.
Speculation: Uncertainties and predictions play a significant role in short-term stock market price fluctuations.
Fast-changing events can lead to intense volatility in stock prices.

Bond Market Risks

Interest rate changes are a major risk factor in the bond market.
There is an inverse relationship between bond prices and interest rates: When interest rates rise, bond prices fall, and vice versa.
This sensitivity of bond prices to interest rates highlights the importance of monetary policy and economic changes influencing the bond market.

Description

Explore the fundamentals of capital markets, including the roles they play in funding and investment. This quiz will cover both primary and secondary markets, key instruments, and their functions in facilitating capital formation and liquidity. Test your understanding of how these markets operate!