Capital Markets

Capital markets are venues where savings and investments are channeled between suppliers—such as companies and governments—and those in need of funds, typically businesses or consumers. These markets facilitate the raising of capital through the issuance of various financial instruments like stocks and bonds.

Types of Capital Markets

Capital markets are generally divided into two main types:

• Primary Market: This is where new securities are created and sold for the first time. Companies issue new stocks or bonds to raise capital directly from investors.
• Secondary Market: In this market, existing securities are traded among investors. The company that issued the securities does not receive any new capital from these transactions.

Functions of Capital Markets

Capital markets perform several important functions:

• Capital Formation: They provide a platform for businesses and governments to raise funds needed for expansion or operations.
• Price Discovery: Capital markets help in establishing prices for securities based on supply and demand.
• Liquidity: These markets ensure that investors can easily buy and sell securities, enabling them to convert investments into cash.
• Risk Distribution: They allow investors to diversify their portfolios, spreading risk across various assets.

Example of Capital Markets

Consider a technology company, Tech Innovations Inc., that wants to expand its operations. To raise the necessary funds, it decides to issue 1 million shares of its stock at an initial public offering (IPO) price of $20 per share.

Calculation of Funds Raised in the Primary Market

To calculate the total funds raised by Tech Innovations Inc.:

• Number of Shares Issued: 1,000,000 shares
• Price per Share: $20
• Total Funds Raised: Number of Shares x Price per Share

Total Funds Raised = 1,000,000 shares x $20 = $20,000,000

Thus, Tech Innovations Inc. raises $20 million through the primary market.

Importance of Capital Markets

Capital markets play a crucial role in economic development by:

• Facilitating investment and growth for businesses.
• Allowing governments to fund public projects through debt issuance.
• Providing individuals and institutional investors a venue to achieve higher returns on their savings.

These markets are vital for efficient capital allocation within the economy, ensuring resources are directed toward productive investments.