Capital Market: Definition & Instruments
The capital market is a financial market in which longer term debt and equity instruments are traded. Capital markets are used to sell different financial instruments including debt and equity instruments with maturities of greater than one year.
These markets are divided into two categories:
Primary market: The primary market is a financial market where new securities are issued and sold to initial buyers for trading. A company issues a new share or bond to the general public to raise capital to finance its long term goals.
Secondary market: The secondary market is a financial market where investors buy and sell previously issued financial instruments such as stocks, bonds, options, and futures contracts.
Capital market intruments have far wider price fluctuations than money market instruments and are considered to be fairly risky investments. The principal capital market instruments are listed below.
- Stocks: Stocks are equity claims on the net income and assets of a corporation. There are two main types of stock: common and preferred.
- Corporate Bonds: These are long-term bonds issued by corporations with very strong credit ratings. The typical corporate bond sends the holder an interest payment twice a year and pays off the face value when the bond matures.
- Government Bonds: State and local bonds, also called municipal bonds, are long-term debt instruments issued by state and local governments to finance expenditures on schools, roads, and other large programs.
- Derivatives: Derivative instruments are financial contracts that derive their value from an underlying asset. These instruments include forwards, futures, options, and swaps.
- Exchange – Traded Funds (ETFs): They are mutual funds traded on equity-exchanges, which are based on an index and aim to reflect the performance of its base index to the investors. ETFs are issued based on an index, and invest in the securities on its base index in proportion to their weight in the index.
The Bottom Line
The capital market is a very important part of the financial industry. They are divided into two different categories: the primary market refers to financial markets where new securities are issued for the first time by companies or governments to raise capital, and the secondary market is the financial market where securities already issued in the primary market are traded among investors.
The key benefit of the capital market is that they allow money to move from those who have it to those who seet it for their own purposes.
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