A Guide to the Financial Capital Market
The term financial capital market refers generally to the place where various parties come together to exchange different financial instruments. In this article, we will explore this concept in detail, explain how this market is broken down into different types, show you how you can participate in the capital market and much more!
What Is the Financial Capital Market?
We can define the financial capital market as a place where savings and investments are exchanged between those who have capital to invest and those that require capital for long term use.
When we refer to those who have capital, we are referring to investors, both retail and institutional, and when we speak of those requiring capital, we are speaking of businesses, governments and people.
In exchange for their capital, investors receive a security, the most common and well known being stocks and bonds.
The financial capital market plays an important role in the economy, allowing companies and governments to access capital more efficiently and, therefore, grow faster; and allowing people and institutions to invest surplus savings. Economies without access to a financial capital market tend to grow much more slowly and offer fewer attractive investment opportunities.
What Are Shares and Bonds?
Shares are units of equity ownership in either a private or public corporation. The shares of privately owned companies are initially held by the founders or partners. However, as companies grow, they may take the decision to raise capital by selling their shares to the public.
A bond is a fixed income instrument, which represents a loan made by an investor to an entity, usually a corporation or a government. Bonds are issued with commitments to, both, a fixed regular payment and a maturity date by which the loan must be repaid. Failing to comply with either commitment means the borrowing entity risks default.
Although their mechanics differ, the purpose of shares and bonds are the same for the issuing party. Both are issued in order to raise capital. For what? In theory, it could be for any reason. For corporations the capital tends to be required for growing the business, funding a particular new project or buying new assets.
Similarly, a government may sell bonds to fund infrastructure, other national projects or to service national debt.
Primary vs. Secondary
The financial capital market consists of two different types of market: primary and secondary.
The Primary Market
In the primary market, investors purchase securities directly from the issuing entity at the time of issue, in what are known as primary offerings.
For example, when a company goes public they have an Initial Public Offering (IPO), in which they sell their shares at a set price to, mostly institutional, investors.
After going public with its IPO, a company can issue and sell shares in subsequent issuance rounds, providing certain conditions are met.
In both cases, since new securities are being bought directly from the issuing company, the transactions are part of the primary market.
The Secondary Market
In the secondary market, pre-existing securities are traded between investors. For example, existing shareholders can sell their shares to others who want to buy them. The issuing company plays no part in this secondary market.
Stock exchanges, such as the London Stock Exchange, typically provide facilities for the primary and secondary capital markets.
The Connections Between Primary and Secondary Markets
The primary and the secondary markets are not entirely separate and, in fact, are very much connected to each other in different ways.
Firstly, all securities traded in the secondary market were, at some point, issued in the primary markets.
Secondly, the existence of a liquid secondary market reassures investors buying shares in the primary market. It gives investors who might at some point not want to own the securities any longer, for whatever reason, a place to sell them for cash.
In markets where a liquid secondary market does not exist (like venture capital or private equity) investors expect more ominous terms from the company before buying any securities. So, by providing liquidity, the secondary market supports the primary market.
Thirdly, if a company that has already had an IPO wants to issue and sell more of the same securities, the price of the new securities is driven by the price of the existing securities in the secondary market.
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Who Are the Main Players?
We now understand what the financial capital market is and how it is split into two different types. But who are the main players within the primary and secondary capital markets? In the following sections, we will explore this subject.
The Primary Market Players
1) The Issuing Party
Firstly, we have the party which requires capital in order to grow their business, fund a particular project or some other reason. Most commonly, this would be a company (shares or bonds) or a government (bonds).
In the case of companies who are looking to go public, as we have already mentioned, they would sell their shares via an IPO.
Individual, or retail, investors can sometimes buy new shares and bonds issued in the primary markets, as long as they go through a broker.
In the case of government bonds, the buying process varies from country to country. In the UK, the Debt Management Office (DMO) sells gilts (bonds) via auction. Retail investors who wish to purchase UK gilts need to do so via a Gilt-edged Market Maker (GEMM).
However, in the US, it is possible for any US citizen to register with the Treasury and buy Treasury bonds directly at auction.
Institutional investors, or institutions, on the “buy side” of the market, consist of fund managers, and other pooled investors who provide the capital required in exchange for the securities being sold. The largest proportion of investments are made by institutional investors.
In the case of shares, whilst sometimes retail investors are able to access shares at an IPO, it is much more common for IPOs to only be accessible to big investors who have a good relationship with the broker taking the company in question public.
4) Investment Banks
The investment banks, on the “sell side” of the market, are used to advise and facilitate transactions between the issuing party and institutions. Part of the responsibility of the investment banks is to match institutional investors with the issuing parties based on the respective risk vs. reward profiles, investment styles and other considerations.
5) Public Accounting Firms
Public accounting firms play an important advisory and accounting role to the issuing party in the primary market.
Regulators play a big role in the primary market, protecting investors and the integrity of the market by ensuring that all the above players adhere to the relevant rules and regulations. In the primary market, their main focus would be on ensuring that the new securities are suitable for external investors and that issuers release accurate and sufficient information to the market.
The Secondary Market Players
1) Investors: Buyers and Sellers
The secondary market is far more accessible for most types of investor. Buyers and sellers can exchange pre-existing securities through a broker in a central marketplace, such as a stock exchange.
2) Investment Banks
As well as being a major player in the primary market, investment banks also play a part in the secondary market. They provide research regarding issuers and securities, helping buyers and sellers make decisions and also trade securities on behalf of their clients.
Regulators also play a big role in the secondary market. Their focus is on ensuring that issuers continue to release accurate and prompt information and that buyers and sellers do not do anything to artificially inflate or depress the prices of securities in their favour.
Can I Trade the Capital Markets with Admiral Markets?
Yes, you can!
With Admiral Markets, you can buy shares or take a position on their price by using Contracts For Difference (CFDs). It is also possible to take a position in certain bonds via CFDs.
In order to buy shares via Admiral Markets, you need to follow these steps:
2. Download the MetaTrader 5 trading platform
3. From your MetaTrader platform, head to the ‘Market Watch’ tab on the left hand side of your screen to search for the public company whose shares you wish to purchase. If ‘Market Watch’ is not displayed, press Control + M to open it.
Depicted: Admiral Markets MetaTrader 5 - Market Watch
4. Once you have selected your desired stock, right click the symbol and open a price chart
5. Hit ‘New Order’ at the top of the screen to buy your desired stock, or to sell stock you already own.
Depicted: Admiral Markets MetaTrader 5 - Apple Inc. Weekly Chart - New Order. Date Range: 5 April 2015 - 21 December 2020. Date Captured: 21 December 2020. Past performance is not necessarily an indication of future performance.
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This material does not contain and should not be construed as containing investment advice, investment recommendations, an offer of or solicitation for any transactions in financial instruments. Please note that such trading analysis is not a reliable indicator for any current or future performance, as circumstances may change over time. Before making any investment decisions, you should seek advice from independent financial advisors to ensure you understand the risks.