If you ask someone ‘what is a capital market?’’ they might answer no; however, if you ask someone ‘what is a share/stock market?’’ they might say yes. In layman terms, capital market is a place to buy or sell the financial securities; these financial securities include shares, bonds, ETFs, listed fund companies, stapled securities etc. Capital market is full of market participants and few regulators, which depends upon the jurisdiction of different markets.
In Australia, the Australian Securities and Investments Commission (ASIC) and Australian Prudential Regulation Authority (APRA) are the two government bodies; collectively both of these organisations oversee the capital markets and financial services. Australian Payments Clearing Association (APCA) regulates the payment services in Australia, and market participants include credit unions, superannuation funds, insurance companies, commercial banks, finance companies, public unit trusts, authorised deposit-taking institutions, institutional fund etc. Some stock exchanges in Australia include the Australian Securities Exchange, Bendigo Securities Exchange & National Stock Exchange of Australia.
Capital markets is a financial marketplace for investors to deal in buying & selling of financial instruments; the most common capital markets include the bond markets and stock/equity markets.
Generally, short-term financial instruments like 3 Month Treasury Notes are bought & sold in the money market – a market for short term fixed income financial instruments.
The scope of capital markets is not limited to equity & bonds only; it also provides trading facilities for commodities and currencies as well. Capital market provides a venue to channelize savings & investments between the provider of capital and the organisations in need of capital. Capital markets hosts a lot of participants that include companies, insurance funds, pension funds, sovereign wealth funds, retail unit trusts, retirement trusts, brokers, custodians, depositories, retail investors, foreign investors, banks, stock exchanges, market intelligence/data providers, rating agencies, research houses and most importantly a regulatory body.
Capital markets facilitate an exchange of financial securities between two parties (trading) while the transaction is supported by a number of other market participants as well.
Market participants in the capital markets
Stock Exchange –Stock exchange is the prime facilitator of trading services between the traders and brokers on a regular basis while it also facilitates the listing of new shares from a company. There can be multiple exchanges in any country to facilitate the services. Stock exchanges provide complete transparency to the traders, investors and the general public, and a government regulator oversees the activities of a stock exchange. ASIC supervises the activities of stock exchanges in Australia.
Retail Investors – Retail investors are commonly referred to as individual investors or non-professional investors. These investors are mostly involved in the buying & selling of securities, mutual funds or Exchange traded funds. These investors trade on securities through brokers, and the capital invested by retail investors is relatively low against institutional investors.
Institutional Investors – An institutional investor is an organization that invests the capital on behalf of other investors; the scale of operations of these investors is mainly large. These investors possess specialized knowledge and resources than an individual investor, and maybe special rights as well. It should be noted that these investors have a high-risk appetite, and these investors also favour investments in derivatives, unlike retail investors.
Regulators – The regulators are the safe keeper of the ethics in any economy or business. In capital markets; these regulators play an essential role in safeguarding the interests of the investors while closely supervising the market activities and investigations. A market regulator closely watches the capital movements, while also investigates matters for potential unfairness.
Brokers – A broker can be an individual person, or a company acting as an agent in executing trades on behalf of clients; these clients may include retail & institutional investors as well. Generally, brokers charge a commission while executing any trade, and sometimes also provide insights on market, investments and intelligence to the customers while dealing in securities. There are different types of credentials required in different jurisdictions to become a broker.
Custodians – Custodians are one of the most important market participants in the capital market, as they hold the customer’ securities to minimise the risk of theft of loss. Custodians hold financial securities mostly fixed income & equities, facilitate the post-trade activities, which include delivery and receipt of financial security for consideration or capital. Mainly, these organisations include big banks offering custodian services to investors.
Depositories – As the name suggests ‘deposit’, these organisations facilitate the deposit or storage. Depository participant or Depository holds the security while assisting in the trading of securities, and these organisations also provide services like transferring of shares from one investor’ account to another. Depositories also provide clearing services like Depository Trust & Clearing Corporation (DTCC) in the USA. Clearing House Electronic Subregister System (CHESS) by ASX provides clearing services in Australia while Central Securities Depository (CSD) provides depository services in Australia.
Rating Agencies – A rating agency or a credit rating agency assesses the ability to repay the principal and interest of any company or government on their debts. These agencies provide ratings on the basis of the financial strength of any entity, and these ratings are widely used by the market to interpret the credibility of the issuer.
Types of Capital Markets:
The Primary market is a type of capital wherein the financial securities are traded for the first time in a stock exchange, and the fresh capital is raised from the market. Underwriters or investment banks facilitate the transactions that require fresh capital and set the floor and cap price according to the valuations. Some primary market offering includes:
Initial Public Offerings
The companies which are not traded publicly (held privately) intends to raise capital for their business objectives via IPO. The companies planning to raise capital generally appoints an underwriter (s), select an exchange and apply for a listing to the market regulator. After the approval is received, requirements must be completed to list the shares in any exchange, and these requirements would vary from jurisdiction to jurisdiction.
As the name suggests ‘Placement’, the securities are placed to a few or several institutional/sophisticated investors on an exclusive basis. The placement is less costly than the public offering, and sometimes listed companies also offer placement of new shares to an exclusive investor.
The Secondary market is a market for financial securities that are pre-owned by the investors or the holder of those securities already owns the shares. It is a market for trading pre-owned securities; the stock exchanges facilitate these markets wherein existing securities from the market change their ownership for consideration. ETFs and Bonds are also traded in the secondary market once they are issued initially. Some of the secondary market examples apart from the trading of securities can be an on market buy-back program of any company, delisting or merger of companies through cash offer.
Primary Versus Secondary Market
Primary market & Secondary market are the two types of capital markets; the main difference between these two markets is that in Primary markets, only newly issued financial securities are issued while in Secondary markets, the existing securities are traded in the market. In primary markets, the raised capital is supplied to the enterprises for their business objectives; however, the capital is not supplied to these enterprises or companies in the secondary market. The Primary market is a one-time market, while the ownership can change multiple times in the secondary market. It can be said that the buying and selling of securities are between companies and investors in the primary market; meanwhile, buying and selling of securities is between the investors only in the secondary market. Underwriter facilitates the issue of new securities in the primary market, and the broker provides the trading services for these securities in the secondary market.
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