Capital markets connect organizations that need funding with investors willing to provide it. Governments and companies issue securities to raise money; investors buy those securities and may later trade them with other investors. The term covers both the market for new securities and the systems and venues that support their trading.
What are capital markets?
Capital markets are a segment of the financial system that channels savings to governments, companies and other organizations seeking capital. The World Bank Group’s Capital Markets Development: A Primer for Policymakers defines them as “a segment of the financial system aimed at channeling the savings of an economy to those in need of capital.” In return for providing capital, investors receive securities that carry rights and risks defined by the instrument and its issuer.
The term is broad. This article focuses on securities markets—such as markets for shares and bonds—and the institutions and processes that support them. Some definitions also include money-market assets, while others use “capital markets” more narrowly for longer-term securities. The boundary depends on context.
How do capital markets work?
The process has two distinct stages: issuing a security to raise funds and trading that security after it has been issued.
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Primary markets: raising new money
In a primary-market transaction, an issuer sells a new security to investors. A company might issue shares to sell ownership interests, or issue bonds to borrow. Governments also issue securities to borrow. The issuer receives the proceeds, subject to the terms and costs of the offering. The World Bank primer describes primary markets as the market for new securities.
Secondary markets: trading existing securities
In a secondary-market transaction, one investor sells an already-issued security to another. The company or government that originally issued it is generally not the seller and does not receive the proceeds from that resale. Secondary trading gives investors a way to buy or sell securities after issuance. The SEC’s glossary defines a secondary market as a market where investors buy securities from other investors, rather than from the issuer.
What is traded in capital markets?
Capital markets can involve several kinds of securities. The specific rights, payment terms and risks depend on the security and its issuer.
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- Stocks or other equity: Shares represent ownership in a company. Their value can rise or fall, and shareholders can lose money. See the SEC’s stocks FAQ.
- Bonds: Bonds are debt instruments. An investor lends to the issuer under specified terms, which may include interest payments and repayment of principal.
- Securitized assets: Mortgage-backed securities are an example of securities created from pools of underlying assets.
- Collective investment interests: Mutual funds and other collective investment schemes offer interests in a pooled investment vehicle.
The World Bank primer discusses these examples, including company equity, government and non-government bonds, securitized assets and collective investment schemes. They are not interchangeable: their claims, payment structures and risks differ.
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Who makes capital markets work?
Issuers seek funding, and investors provide capital while taking on investment risk. Other participants and institutions help securities move from issuance to trading and settlement.
- Brokers and other intermediaries help investors and issuers access markets and arrange transactions.
- Exchanges and other trading venues provide mechanisms for buying and selling securities.
- Clearing agencies help determine the obligations of parties after a trade.
- Depositories and settlement systems support the transfer and recording of securities and payments.
- Regulators oversee markets under rules that vary by jurisdiction and by the type of security or activity.
These roles and infrastructure are described in the World Bank primer and, for the U.S. securities context, Investor.gov’s overview of market participants. The details are not universal: market structures and regulatory responsibilities differ across countries and instruments.
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Where are securities traded?
Securities may trade on exchanges or through over-the-counter (OTC) arrangements. An exchange organizes trading under institutional rules and disseminates market information. OTC trading takes place outside an exchange’s centralized trading mechanism, although the arrangements can vary substantially by market. The IMF explains this distinction in its overview of financial markets.
A trade is not necessarily complete when buyer and seller agree. Clearing processes establish what each party owes, and settlement completes the transfer of securities and funds. How these processes work depends on the market infrastructure and applicable rules.
How are capital markets different from money markets?
The terms are not always used with the same boundary. Some definitions of capital markets include money-market assets, while others reserve “capital markets” for longer-term securities such as shares and bonds. It is safest to check how a particular source or institution defines the term rather than assume that every use draws the line in the same place.
What risks do investors face?
Capital-market securities are investments, not guaranteed bank deposits. A security can lose value, and an investor may lose some or all of the money invested. The nature and extent of risk depend on factors such as the issuer, the instrument’s terms and market conditions. For example, stocks can fall in price; bond and securitized-asset risks have their own features. Investors should understand the security and its risks rather than assume that market trading or an issuer’s name guarantees a return.
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