Introduction to Capital Markets

Study Notes

Introduction to Capital Markets

Capital markets are financial markets where long-term debt and equity instruments are traded.
They facilitate the flow of capital from savers to borrowers.
Key players include investors, issuers, and intermediaries, all crucial for economic growth and development.

Types of Capital Markets

Debt markets:
- Issuers borrow money by issuing bonds, notes, or mortgages, receiving interest payments that can be fixed or variable.
- Examples include government bonds, corporate bonds, and mortgage-backed securities.
Equity markets:
- Issuers raise capital by selling shares of ownership in their company (stocks) to investors.
- Investors gain potential profits through dividends and capital appreciation.
- Examples include common stock, preferred stock, and initial public offerings (IPOs).
Money markets:
- These are short-term markets dealing in highly liquid debt instruments, typically with very low risk and high liquidity.
- Examples include treasury bills, commercial paper, and certificates of deposit (CDs).
Foreign exchange markets (Forex):
- Facilitates the trading of currencies worldwide, affecting interest rates and exchange rates, and is critical for international trade and investment.

Functions of Capital Markets

Mobilizing savings:
- Channel savings into productive investments, matching savers' funds with borrowers' needs.
Pricing of risk:
- Capital markets assess and price risks of various investments, ensuring rational allocation of capital.
Allocating capital efficiently:
- Ensures that capital flows to the most productive uses, ultimately spurring economic growth and development.
Facilitating corporate financing:
- Provides companies with access to capital for expansion and investment.

Key Players in Capital Markets

Investors:
- Individuals, institutions, and funds that invest in securities, driven by returns and risk tolerance.
Issuers:
- Corporations, governments, and other entities seeking to raise capital, aiming to maximize returns within their specific risk profiles.
Intermediaries:
- Banks, brokers, and other financial institutions that facilitate trading, providing services like underwriting, trading, and investing.

Market Mechanisms

Auction markets:
- Securities are traded in an organized exchange (e.g., NYSE), with buyers and sellers meeting at a central location.
Dealer markets:
- Dealers hold inventories and trade directly with clients (e.g., over-the-counter market), with prices determined by supply and demand.

Importance of Capital Markets

Economic growth:
- Enables businesses to raise capital, encouraging investment in new projects and infrastructure.
Risk management:
- Offers tools for managing risk, allowing investors to diversify their portfolios.
Efficiency:
- Facilitates efficient allocation of capital, with prices reflecting available information.

Regulations and Oversight

Capital markets are subject to regulations enforced by regulatory bodies guaranteeing fair and effective functioning, though regulations vary across jurisdictions.

Challenges in Capital Markets

Liquidity risk:
- Difficulty in quickly selling assets.
Credit risk:
- Risk issuers may default on debt obligations.
Market risk:
- Changes in market conditions (e.g., interest rates or economic outlook) affect investments.
Information asymmetry:
- One party possesses more information than others.
Volatility:
- Significant fluctuations in asset prices.

Description

This quiz covers the essentials of capital markets, focusing on how long-term debt and equity instruments are traded. It provides insights into the key players involved and the types of capital markets, including debt, equity, and money markets, essential for economic growth. Test your knowledge on the functioning and significance of these financial markets.