What Is a Capital Market?

Capital markets, often referred to as financial markets, connect individuals, corporations and governments with excess funds (capital) to those in need of financing for growth, projects or other needs. These markets come in various forms, including stock markets, bond markets and commodity markets, where securities are actively bought and sold by investors seeking returns on their investments. By efficiently matching capital suppliers with those in need, capital markets play a critical role in the global economy, fostering innovation and growth.

A financial advisor can help you identify the best opportunities for your investment goals, minimize risks and craft a strategy tailored to your financial future.

What Are Capital Markets?

Capital markets are financial systems where savings and investments flow between providers of capital and those who need it. Providers typically include banks, financial institutions and investors with funds available to lend or invest.

On the other side, businesses, governments and individuals actively seek capital in these markets to fund operations, projects or other needs. The stock market and bond market are the most prominent examples of capital markets. By connecting suppliers with those in need of capital, these markets enhance transactional efficiency, creating a structured environment for the exchange of securities.

How Do Capital Markets Work?

The term “capital market” refers to the physical and digital platforms where various entities buy and sell financial instruments. These markets encompass the stock market, bond market and foreign exchange (forex) market, among others. They are typically concentrated in global financial hubs like New York, London, Singapore and Hong Kong.

Capital markets connect the suppliers and users of funds. Suppliers include individual households, often through savings accounts and other banking products, as well as institutional players such as pension funds, retirement accounts, life insurance companies, charitable organizations and businesses with surplus cash reserves.

On the other side, users of these funds include individuals purchasing homes or vehicles, businesses seeking capital for operations or growth, and governments funding infrastructure projects and other expenses.

Capital markets primarily facilitate the sale of financial instruments like equities and debt securities. Equities represent ownership stakes in companies, while debt securities, such as bonds, are interest-bearing obligations.

These markets are further categorized into two types:

Primary markets: Where newly issued stocks and bonds are sold directly to investors.
Secondary markets: Where existing securities are bought and sold among investors.

Primary vs. Secondary Capital Markets

There are two main forms of capital markets: primary and secondary markets.

In a primary market, investors buy financial products directly from the institutions which create them (such as the companies issuing the stocks or the institutions issuing the bonds). All of the capital that moves in a primary market goes to the individual or institution seeking that money.

For example, on a primary bond market the buyer who purchases a bond gets it directly from the institution looking for that loan. On a primary stock market, investors buy shares directly from the company that’s looking for an investment. Companies and other institutions only receive capitalization from the primary market.

It’s rare for individuals to participate in primary markets by nature of their sheer size. Most primary market sales involve multi-million-dollar transactions, putting them well beyond the reach of the average investor. Primary markets are, instead, mostly populated by institutions such as banks, investment funds and other large-scale investors.

Most individual investors will participate in secondary markets. On a secondary market, investors buy and sell financial products among themselves. The money that changes hands does not go to the institution seeking capital, but rather is exchanged among investors.

For example, most trades on the stock exchange are considered a secondary market. Here, an individual will own shares of a stock and will sell those shares to another individual. The underlying company neither participates in the transaction nor receives any of the money.

Other Types of Capital Markets

Capital markets can come in many different forms and sizes. Stock markets such as the New York Stock Exchange, the NASDAQ or the London Stock Exchange are all examples of capital markets that deal in equities. The Chicago Mercantile Exchange is a capital market dealing in commodities. The most common types of capital markets are:

Equities – In a stock market, investors will generally trade capital for shares of ownership in a company. In exchange, the company receives this money to spend on its own growth and operations.
Bonds – In a bond market, investors will lend money to an institution in exchange for a promise to repay that loan plus interest.
Commodities – In a commodities market, investors will buy contracts for raw materials and processed goods in exchange for a promise to pay the future price of those products.
Currency – In a currency market, investors will sell currency (such as dollars, euros and pounds) to other individuals and institutions looking for spendable money in a given market.

Benefits of Secondary Markets

Secondary markets are generally the largest capital markets both by trading volume and by value. Most stock and bond trading that happens, for example, occurs on the secondary market. The only exception is when shares are sold as part of a public offering (when a company creates, issues and sells shares of ownership).

Even though none of the money exchanged on the secondary market directly capitalizes corporations that issue stock or entities that issue bonds, they still derive benefits from secondary market activity. These markets increase liquidity and promote sales on the primary market. When investors buy assets on the primary market, they rarely do so intending to hold those assets for long periods of time. The ability to sell assets on the secondary market for a profit makes it more likely that investors will buy those assets on the primary market, and that they will spend more for them.

Corporations also benefit from secondary markets because changes in the value of securities traded on secondary markets can affect the ability of those entities to borrow money. The higher the share price the greater a corporation’s ability to borrow money (and vice versa). Further, corporations often buy their own shares on the secondary market. This boosts their share price, to lower their cost of capital. It directly affects the ability of corporations to launch capital projects, like building a factory or launching a product line.

Secondary markets also allow for market corrections through their sheer volume of trading. Traders will identify weak business models over time, particularly as information becomes available that might not have been available during a primary market sale. This lets future investors know how to approach a company when it issues new assets on the primary market.

The broader economy benefits from rising share prices because it boosts consumer confidence, which spurs spending. This is sometimes known as the wealth effect.

Bottom Line

Capital markets, also known as financial markets, enable trading of stocks, bonds, currencies and commodities. They come in two varieties, primary and secondary. The former facilitate trades between entities that create securities and buyers, typically large or institutional buyers; the latter facilitate trades among investors, not the entities that created the securities.

Capital Market Tips

Consider talking to a financial advisor about the various ways to invest in secondary capital markets. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area. You can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
Long-term investors look for capital markets, buying assets that they might hold for months or even years. Short-term investors look for something quite different. They channel their assets into the money markets, and you can learn all about it here.