Capital markets are an important economic driver that you've likely never heard about if you're not in the financial industry. These markets drive job creation and financial security and help people buy homes, save for retirement and education and fund and grow their businesses. Capital markets also help communities provide essential services, including necessary infrastructure repair and creation.
What Is a Capital Market?
A capital market consists of suppliers and users including individuals and institutions that trade financial securities such as bonds and stocks. The basic purpose of a capital market is to gather funds from some entities and make them available to other entities that are in need of funds.
The "suppliers" in a capital market include households and the institutions serving them such as pension funds, life insurance companies, charitable foundations and non-financial companies that have generated more cash than needed for investment. The "users" include people who are purchasing homes and motor vehicles, non-financial companies and governments that are financing infrastructure investment and operating expenses.
Functions of Capital Market
A capital market has several functions and is a measure of the economy's overall strength.
- Move savings to finance long-term investments.
- Enable the trading of securities.
- Decrease the cost of transactions and information.
- Improve the effectiveness of capital allocation.
How a capital market might work: A government wants to raise long-term finances so it sells bonds in the capital markets. Investment banks are used to organize the sale of these bonds, however, it has become more and more common for governments of larger nations to bypass investment banks and make their bonds directly available for purchase online via a computerized auction.
Capital Market Examples
The New York Stock Exchange is an example of a highly organized capital market. Other examples include the American Stock Exchange, the London Stock Exchange and NASDAQ.
Other, less organized and official capital markets include entities whose business fundamentals don't meet the minimum standards of a formal exchange, like the New York Stock Exchange. These entities still buy and sell, but do it "over the counter" so to speak, rather than through a recognized exchange.
Because capital markets are interconnected, a disturbance in a capital market on the other side of the globe can impact trading in other countries' markets.
The Securities and Exchange Commission regulates the reporting of information by any entity that wishes to issue or trade securities in a capital market in the United States.
Heather Skyler is a business journalist and editor who has written for wide variety of publications, including Newsweek.com, The New York Times and Delta's SKY magazine. She has a bachelor's degree in English from Miami University and a master's degree in writing from the University of Washington in Seattle. Before writing for a variety of publications, she taught business writing in Seattle.