Understanding Capital Markets: Equity and Debt

• Capital markets facilitate the exchange of funds between suppliers of capital (investors) and those who demand capital (companies, governments).
• They play a crucial role in allocating resources efficiently and supporting economic growth.
• Capital markets can be broadly divided into equity markets and debt markets.

Equity Markets

• Equity markets are where stocks or shares of companies are bought and sold.
• Represent ownership in a company.
• Investors become shareholders and are entitled to a portion of the company's profits and assets.
• Stocks can be common stock or preferred stock.
• Common stock gives voting rights.
• Preferred stock usually does not give voting rights but has a higher claim on assets and earnings.
• Key functions include: price discovery, liquidity, and corporate governance.
• Stock exchanges provide a centralized platform for trading.
• Examples include the New York Stock Exchange (NYSE) and the Nasdaq.
• Initial Public Offerings (IPOs) occur when a private company offers shares to the public for the first time.
• Secondary markets allow investors to trade previously issued shares.
• Market indices like the S&P 500 and the Dow Jones Industrial Average (DJIA) track the performance of equity markets.

Debt Markets

• Debt markets involve the trading of debt instruments, such as bonds, notes, and commercial paper.
• Represent a loan made by an investor to a borrower.
• The borrower promises to repay the principal amount along with interest.
• Debt instruments can be issued by governments, corporations, and other entities.
• Government bonds are considered relatively low risk.
• Corporate bonds carry a higher risk of default.
• Credit ratings assess the creditworthiness of debt issuers.
• Rating agencies like Moody's, Standard & Poor's, and Fitch provide these ratings.
• Bond yields reflect the return an investor can expect to receive from a bond.
• The yield is influenced by factors such as interest rates, credit risk, and maturity.
• The bond market is significantly larger than the equity market.
• Money market is a segment of the debt market that deals with short-term debt instruments (maturity of less than one year).

Market Regulation

• Market regulation aims to ensure fair and efficient capital markets.
• Protects investors.
• Prevents fraud and manipulation.
• Common regulatory bodies include the Securities and Exchange Commission (SEC) in the U.S.
• Regulations address issues such as insider trading, disclosure requirements, and market manipulation.
• Insider trading is the illegal practice of trading securities based on non-public information.
• Disclosure requirements mandate that companies provide transparent and accurate information to investors.
• Regulations promote market integrity and investor confidence.
• Self-regulatory organizations (SROs) like the Financial Industry Regulatory Authority (FINRA) also play a role in market oversight.

Investment Strategies

• Investment strategies involve different approaches to allocating capital in capital markets.
• Aim to achieve specific financial goals.
• Passive investing involves tracking a market index.
• Active investing seeks to outperform the market through stock selection and market timing.
• Value investing focuses on buying undervalued assets.
• Growth investing targets companies with high growth potential.
• Diversification is a key principle aimed at reducing risk by spreading investments across different asset classes.
• Asset allocation involves determining the optimal mix of assets in a portfolio.
• Risk tolerance and investment horizon are important factors in determining investment strategies.
• Technical analysis uses historical price and volume data to identify trading opportunities.
• Fundamental analysis involves evaluating a company's financial statements and business prospects.

Capital Market Instruments

• Capital market instruments are the various types of securities traded in capital markets.
• Equities (stocks) represent ownership in a company.
• Debt instruments (bonds, notes) represent loans to companies or governments.
• Derivatives are contracts whose value is derived from an underlying asset.
• Examples include options, futures, and swaps.
• These can be used for hedging or speculation.
• Mortgage-backed securities (MBS) are bonds secured by a pool of mortgages.
• Asset-backed securities (ABS) are bonds secured by other types of assets, such as loans or credit card receivables.
• Mutual funds pool money from multiple investors to invest in a diversified portfolio of securities.
• Exchange-traded funds (ETFs) are similar to mutual funds but trade on stock exchanges like individual stocks.
• Hedge funds are private investment funds that use more complex investment strategies.
• Structured products are customized investment products designed to meet specific investor needs.
• Private equity involves investments in private companies not listed on public exchanges.
• Real estate investment trusts (REITs) invest in real estate properties and distribute income to shareholders.