What Are Capital Markets?
Capital Markets are a type of financial market where long termer debts and equities are traded or originated. Governments, businesses and institutions can turn to capital markets to raise money through borrowing, or in exchange for equities. The debt instruments or equities can also be resold in capital markets.
What Is Meant By Short, Medium, or Long Term?
Medium or long term can be subjective. In finance and accounting, long term is generally considered a period greater than one year. Fixed assets on a balance sheet are assets that have a life over a year implying capital markets are geared towards raising capital in alignment with longer term assets on the balance sheet. Conversely, short term refers to a time period of less than a year.
Money Markets Versus Capital Markets
Money markets are the second type of financial market that complement the need served by capital markets. The difference is money in money markets is raised for short term financial needs through short term financial instruments. Where long term financial assets underpin capital markets, short term liquid assets are traded in money markets. This implies financing vehicles in money markets are aligned with the needs of current assets on the balance sheet.
Primary and Secondary Markets In Capital Markets
The primary markets are the frontlines of the capital markets. They are where loans are originated and equities are issued. Once these debts and equities are created in the primary markets, they can be traded with investors as securities or as other types of financial instruments.
The secondary markets are a key component of the financial system. They provide liquidity to fund the issuances of new loans and stocks. Secondary markets provide a channel for savings to find its way to those who need to borrow or raise equity capital. They allow money to move from savers to those who need money to fuel investment and economic activity.
Simplified Illustration Of Primary and Secondary Markets
To illustrate the primary market, imagine Lender Bill lends $100,000 at 10% per year and holds the note on the borrower's property. At the end of the first year, Lender Bill will get $110,000 back. That's a nice $10,000 profit over the year. However, he will have to wait a year to realize his return, and in the meantime he knows someone else who'd like to borrow some money.
Ivestor Irene happens to have $105,000, but would like to use it to earn some interest. Through the secondary market, Lender Bill can sell the note to Investor Irene at a discount. If Investor Irene buys the note for $105,000, she'll get back $110,000 at the end of a year, making a $5000 return on her money.
In the meantime, Lender Bill has cashed out of the loan he issued for $105,000 immediately making a $5000 profit, but also has $100,000 back in hand to lend to someone else. He immediately lends the $100,000 and repeats the process.