What Are Capital Markets?
Episode #1 of the course Introduction to capital markets by Doha Soliman, CFA
Welcome!
Over the next ten days, I will present you with a framework of the capital markets. We’ll cover stock markets, bond markets, security exchanges, and different financial instruments, as well as basics of cryptocurrencies and real estate investing. Whether helped by a professional or attempting to start your own investment portfolio, it is essential to understand the inner workings of the financial markets. By the end of this course, you should have enough information to understand the basics of the capital markets and investment processes.
Stocks, Bonds, and Other Securities
Before we begin with our overview of capital markets, it is essential to understand its two key components: stocks and bonds. When a corporation wishes to raise funds for its operating expenses or for expansion, they do so by issuing stocks or bonds. A stock is a share in the ownership of a corporation. By owning stock, individuals have a claim on the corporation’s earnings and assets. A bond, on the other hand, represents an amount of money an individual is lending to a corporation or government with specific predefined terms, such as maturity date and interest.
Since corporations can technically be owned by individuals, corporations can issue both stock and bonds. Governments, however, cannot have owners and are limited to issuing bonds only.
When building an investment portfolio, individuals generally begin with stocks and bonds. As they become more familiar with capital markets, they can include other financial instruments such as options, futures, and forwards. We will talk about all of these in more detail over the next nine days.
Stocks, bonds, options, futures, and forwards are collectively referred to as “securities”
Let’s now examine the key players who make up the trading arena.
Key Players
There are several players within capital markets. They include traders, financial institutions, regulators, and analysts.
Traders execute the two sides of the trades: They can be on the buy side or sell side, and their key role is risk management and speculation.
Financial institutions are banks that provide the platform required to trade investments. Such banks typically employ traders on an agency basis.
Since capital markets are highly scrutinized due to recent financial crises, governments (regulators) are increasingly taking on more prominent roles in shaping financial institutions’ policies. They regulate trading activity, corporate financial reporting, and their main purpose is to protect the integrity of capital markets and investors.
Finally, analysts play a key role in financial markets as they utilize financial models to analyze quantitative data in determining a corporation’s fair value. Doing so provides the markets with liquidity and efficiency in pricing.
Price Movements
The capital markets operate based on the economic laws of supply and demand, and price securities accordingly. Simply put, if there is a high demand for a stock, its price will invariably go up. However, if individuals begin dumping a stock, its price will suffer.
While financial markets globally are always buzzing, stock markets and bond markets have hours of operation specific to each exchange. For instance, the New York Stock Exchange (NYSE) operates from the hours of 9:30-4:00 p.m. EST, while the London Stock Exchange (LSE) operates from 8:00-4:30 p.m. GMT. As the economic, political, and environmental factors change throughout the trading day, those external shocks affect demand for stocks and bonds and thus, their price.
Primary vs. Secondary Markets
The capital markets can refer to primary or secondary markets. In the primary market, an organization that needs to raise funds issues debt (bonds) or equity (stocks).
Once the funds are raised through these securities, they can be traded in the secondary market among different parties: individuals, corporations, and funds. In essence, the securities traded are identical. The primary difference between the primary and secondary markets is that in the former, securities are purchased from the organization for the first time, whereas in secondary markets, they are traded between any two parties.
Now that you’ve become more familiar with capital markets and we’ve covered some of the terminology, tomorrow, we’ll take a deeper look at stocks. We’ll discuss who trades them, how they are priced, and how you can start your own equity portfolio.
Recommended book
Financial Times’ Guide to the Financial Markets by Glen Arnold
Share with friends