Capital markets are markets where people, companies, and governments withmore funds than they need (because they save some of their income) transfer those funds to people, companies, or governments who have a shortage of funds(because they spend more than their income). Stock and bond markets are twomajor capital markets. Capital markets promote economic efficiency bychannelling money from those who do not have an immediate productive use for it to those who do.Capital markets carry out the desirable economic function of directing capital toproductive uses. The savers (governments, businesses, and people who savesome portion of their income) invest their money in capital markets like stocksand bonds. The borrowers (governments, businesses, and people who spendmore than their income) borrow the savers' investments that have been entrustedto the capital markets.For example, suppose A and B make Rs. 50,000 in one year, but they onlyspend Rs.40,000 that year. They can invest the 10,000 - their savings - in amutual fund investing in stocks and bonds all over the world. They know thatmaking such an investment is riskier than keeping the 10,000 at home or in asavings account. But they hope that over the long-term the investment will yieldgreater returns than cash holdings or interest on a savings account. Theborrowers in this example are the companies that issued the stocks or bonds thatare part of the mutual fund portfolio. Because the companies have spendingneeds that exceeds their income, they finance their spending needs by issuingsecurities in the capital markets.
The Structure of Capital MarketsPrimary markets:
The primary market is where new securities (stocks and bonds are the mostcommon) are issued. The corporation or government agency that needs funds(the borrower) issues securities to purchasers in the primary market. Biginvestment banks assist in this issuing process. The banks underwrite thesecurities. That is, they guarantee a minimum price for a business's securitiesand sell them to the public. Since the primary market is limited to issuing newsecurities only, it is of lesser importance than the secondary market. Secondary market:
The vast majority of capital transactions, take place in the secondary market. Thesecondary market includes stock exchanges (like the New York Stock Exchangeand the Tokyo Nikkei), bond markets, and futures and options markets, amongothers. All of these secondary markets deal in the trade of securities. Securities:
The term "securities" encompasses a broad range of investment instruments.Investors have essentially two broad categories of securities available to them:1.Equity securities (which represent ownership of a part of a company)2. Debt securities (which represent a loan from the investor to a company or government entity). Equity securities:
Stock is the type of equity security with which most people are familiar. Wheninvestors (savers) buy stock, they become owners of a "share" of a company'sassets and earnings. If a company is successful, the price that investors arewilling to pay for its stock will often rise and shareholders who bought stock at alower price then stand to make a profit. If a company does not do well, however,its stock may decrease in value and shareholders can lose money. Stock pricesare also subject to both general economic and industry-specific market factors. Inour example, if Carlos and Anna put their money in stocks, they are buying equityin the company that issued the stock. Conversely, the company can issue stockto obtain extra funds. It must then share its cash flows with the stock purchasers,known as stockholders.
Savers who purchase debt instruments are creditors. Creditors, or debt holders,receive future income or assets in return for their investment. The most commonexample of a debt instrument is a bond. When investors buy bonds, they arelending the issuers of the...
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