Capital market

The essentials

The capital market refers to the facilities and institutional arrangements through which medium-term and long-term funds, both debt and equity, are raised and invested. Its participants include individuals, companies, banks, financial institutions and mutual funds. It has two parts: the primary market and the secondary market.

Key points

• Primary market (new issues market): deals with new securities issued for the first time. It contributes directly to capital formation. Methods of floatation include offer through prospectus, offer for sale, private placement, rights issue (offer to existing shareholders), and e-IPO (issue through the online system of the stock exchange).
• Secondary market (stock exchange): deals with the purchase and sale of existing securities. It contributes indirectly to capital formation by providing liquidity. It has a definite location (the stock exchange), and prices are determined by demand and supply.
• Primary vs secondary: in the primary market only buying by investors takes place and the company receives the money; in the secondary market both buying and selling take place among investors, and the company does not receive the money.
• Capital market vs money market: the capital market deals in long-term securities (shares, debentures), needs larger investment, has higher risk and higher expected returns, and its instruments are less liquid; the money market deals in short-term instruments with lower risk and lower returns, and its participants are mainly financial institutions.

Exam tips

• A rights issue offers new shares to existing shareholders in proportion to their holding.
• Private placement means allotting securities to institutional investors and selected individuals.

Common mistakes

• Thinking companies receive money when their shares are traded on the stock exchange. Only primary issues bring money to the company.
• Treating the secondary market as the place where new shares are issued.