Capital Market is a part of the financial market where companies and institutions raise finances through issuing and trading various long-term financial securities.
Companies Require Two Types of Finance
- Short term (working capital) – Financing through issuing of securities of money market
- Long-term (fixed capital) – Financing through issuing of securities of capital market
Capital Market and its Instruments
The financial market consists of the money market and capital market.
A capital market is a marketplace of long-term securities like shares, bonds, debenture, treasury bills, and other financial instruments issued, traded, and exchanged. The capital market consists of the two-part primary market where new securities are issued and a secondary market where old securities are traded between interested parties.
Participants in Capital Market
The capital market plays a vital role in economic development by facilitating the capital market participants. The participants of the capital market are as follows
- Securities: It is a financial instrument representing an ownership position in a public company and also a credit relation with either government body or companies.
- Security issuers: Companies that issue the securities with collecting capital are called securities issuers.
- Investors: Any subjects who purchase securities with the expectation of dividends are called investors; Investors can be a person or any institution or organization.
- Merchant bankers: These are the institutions/Banks which are specialized in underwriting; Merchant banks make an investment in businesses of private equity.
- Credit rating companies: Independent companies who evaluate financial companies of securities issuers, after evaluation they give a rating on the ability to pay back the debt of issuing securities.
- Stock exchange: The stock exchange is a marketplace where already-issued securities are traded among the securities holder.
- SEC: The Securities and Exchange Commission is a regulatory body that sets and controls secondary markets within a country.
- Stock Brokers: Stockbrokers have licensed agents who execute buying and selling of securities as a representative of investors.
- Stock Dealers: Dealers are the organizations who buy and sell securities of companies of their own, and later they sell those securities to investors.
Roles of Capital Market in the Economic Development
Capital Formation
Capital formation is a process of capital accumulation, and the capital market forms capital for meeting the long-term capital requirements of companies. There are two parts to the capital market. One of which is the primary market, where companies issue new long-term equities to form capital.
Avenue Provision of Investment
The capital market provides equity and debt capital for a long period of time; the capital market makes an avenue of investment for people. People who want to make long-term investments and make a capital gain from that investment can invest in this avenue. It also provides a higher rate of return than most other investment instruments making it a valuable marketplace. As of 2018 global market value of this investment avenue was almost 70 trillion dollars, which is around 81 percent of the total GDP of the Earth at that time. This statistical data shows how much vital the position of the capital market for the formation of capital and making avenue provision. (all-stocks-capitalization-around-the-world)
Speed up Economic Growth and Development
Making funds available for long periods capital market solves the resource problem for long-term investment of industries. Public and private companies of different sectors require long-term capital for operational expansion and increasing production capacity. That business expansion leads to the generation of more jobs, increasing company profit, increasing government tax on the company. Besides, increasing production helps to make more taxation on export and products.
Mobilizing of Saving
By providing a channel of investment at more productive investment opportunities capital market mobilizes scattered idle savings of people of a country. Many people have idle savings, and the capital market accumulates those savings and puts them in proper investment with a higher rate of return.
Service Provision
Service provision means a wide range of services or activities the capital market does. The capital market provides long-term and mid-term investment opportunities, capital gain opportunities, jobs for the underwriter, stockbroker, and dealer, work variety for investment and merchant banks. The stock market also provides market performance indications with 24 hours live performance measures of all unlisted companies.
Appropriate Regulation of Funds
Under the regulation of security and exchange commission’s capital markets worldwide are regulated. The rules and guidelines of the SEC capital market protect the interest of the investors, ensure the proper issuance of securities, and comply with the security laws. The capital market makes sure that companies with IPO show their actual and valid financial reports to protect the investors from any deceiving act of companies.
Continuous Availability of Funds
The capital market provides an avenue where investment is possible at any moment. The capital market has a secondary marketplace where existing security holders and probable investors trade long-term securities. It makes funds available at any time, and this trading of securities is done daily with active trading in the marketplace providing liquidity.
Role as a Transmission Mechanism
The capital market works as a transmission mechanism of idle money by linking deficit and surplus units of an investment opportunity. The role of the transmission mechanism boosts investment and reduces the investment delay seen in other sources of the transmission mechanism.
Divert Resources from Unproductive Resources
The capital market helps invest in various companies in different industries. Each company provides a different rate of return based on its industry’s performance. Besides, diverting resources also helps in reducing the risk of loss by making portfolio investments at different stocks and bonds. The capital market investment, especially in stock, is very much productive than any other form of investment, as it does not promise a constant rate of return. Meaning that dividends from stock can be as high as 100% of investment within a year or two. One example of Capital market productive investment is the investment in Tesla stock. A long-term investment of 1000 dollars in Tesla.inc in 2016 would have yielded 3025% stock value by 2020, making the investment value 30 times greater. (www.cnbc.com) (stocks/tsla/historical)
These are the roles played by the capital market that significantly affect the growth of a country’s economy.
Related Reading
Bibliography
- all-stocks-capitalization-around-the-world. (n.d.). Retrieved from https://howmuch.net/articles/all-stocks-capitalization-around-the-world
- history.com. (n.d.). Retrieved from https://www.history.com/this-day-in-history/facebook-raises-16-billion-in-largest-tech-ipo-in-u-s-history
- stocks/tsla/historical. (n.d.). Retrieved from https://www.nasdaq.com/market-activity/stocks/tsla/historical
- www.cnbc.com. (n.d.). Retrieved from https://www.cnbc.com/2021/11/04/how-much-youd-have-if-you-invested-in-tesla-1-5-and-10-years-ago.html
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