Capital markets feature heavily in business and it is hard to imagine that the world ever got along without them. They have evolved from a small secluded market to large concerns which cannot escape the attention of all members of society. The features of capital markets are many. These capital market features include a high degree of regulation, a wide variety of investors, presence of intermediaries and high liquidity. Before we dive into the capital market features let us define capital markets to understand the context.
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What Are Capital Markets?
A capital market is a financial market in which long-term debt or equity-backed securities are bought and sold. Capital markets channel the wealth of savers to those who can put it to long-term productive use, such as companies or governments making long-term investments. Stock markets and bond markets make up great examples of capital markets. The features of capital markets can be best understood by looking at the “how” and “why” behind the use of the markets. Capital markets feature a primary and secondary market. In the primary market, the savers give money directly to the organisations that seek funding in exchange for a security in the form of a share, debenture or bond. In the secondary market, money is paid to owners of existing securities for securities they have purchased from borrower organisations.
Connects Savers And Borrowers
Capital markets are comprised of two distinct groups. Individuals and organisations with surplus money (savers) and on the end organisations which have projects or enterprises they would like to engage in and are looking for funding to do so (borrowers). The savers offer their surplus money to borrowers with the expectation of some return on their money. The return can come in the form of interest payments, dividend, capital appreciation and/or repayment of the initial amount depending on the type of instrument. This capital market feature is responsible for the huge growth we have seen in capital markets.
Medium to long term
Another prominent capital market feature is the medium to long term nature of relationships. Capital markets contain investment instruments such as shares which have an indefinite life span, debentures which can have a redemption date and bonds which have maturity dates not shorter than 12 months. The relationships are therefore long term. However, the next feature of capital markets ensures that participants are not locked in for the long term if they desire not to be.
High liquidity is another very prominent capital market feature. Due to the existence of the secondary market, savers who purchase securities are capable of selling these securities on the open market if they choose to dispose of their security. This is another capital market feature that has helped them grow in popularity. It allows both easy entry and exit into capital markets at any point in time. The price in the secondary market is determined by the market and largely depends on confidence in the case of shares while bond value depends on a calculated value based on the interest rate and time to maturity (payback).
Capital markets feature financial intermediaries in their processes. While capital markets feature low barriers to entry individuals with a desire to participate in capital markets still have to go through financial intermediaries to participate in the markets. Depending on the environment intermediaries can be low cost or high cost. To buy shares, for example, buyers would need to engage a stockbroker to transact for them on the market. Stockbrokers would also be utilised in a selling transaction.
Another important feature of capital markets is the high degree of regulation that exists in these markets. Capital markets involve organisations taking money from people with the promise or hope of future returns through appreciation or interim payments. As such capital markets feature participants from all walks of life and some or all of these groups may require protection of their investments. Capital market borrowers are heavily regulated in many aspects. Everything from their financial reporting, conduct, how they approach investors, how much information they should disclose and the character of people put in charge of these organisations are all regulated. This task usually falls under the supervision of the Securities and Exchange Commission (SEC) of a country.
Marketable and non-marketable securities
For the most part, we have focused on securities which are traded on open public markets. These are called marketable securities. Capital markets feature non-marketable securities, these are securities which due to the aforementioned heavy regulation are not traded on an open market. This does not prohibit holders from selling them to willing buyers, it simply prohibits the marketing of shares and debentures in certain types of business on the open market. Shares or debentures in small to medium enterprises (SMEs) are a good example of this.
Variety of investors
There are of course many different types of investors that feature in capital markets. Earlier we observed that the savers or investors can be individuals or organisations. Investors in capital markets range from individuals, other organisations such as companies, pooled fund groups such as mutual or hedge funds and institutional investors such as pension and insurance funds. All these investor types have differing needs from capital markets. This capital market feature is responsible for some of the volatility experienced in capital markets with different types of investors responding to stimuli in different ways.
Another common feature of capital markets is the presence of foreign investors in the markets. People and organisations in one country may seek investment options in another country to diversify their investment or to seek a better return. Capital markets thrive where there is the free flow of capital across borders. Depending on the performance of the economy and capital market and the lack of barriers to moving money capital markets can easily be dominated by foreign investors.
In conclusion the features of capital markets include high liquidity, heavy regulation, financial intermediaries and a wide variety of investors.