Introduction to Capital Markets

Introduction

Financing for governments and corporations was originally dominated by a bilateral relationship between borrower and bank. As economies and companies grew, there was a need to raise larger and larger amounts of finance and with this came the need to distribute the risks that had become too large for a single bank.

The capital markets have become the means to achieve this diversification by allowing the issuance of tradable debt and equity securities by companies and governments. Initially, these markets had a physical nature but they have increasingly become “de-materialised”, becoming either an electronic trading system or even just a web of interested parties. The capital markets are generally regulated by institutions such as the Securities and Exchange Commission in the US and the Financial Services Authority in the UK, but the international and virtual nature of these markets poses a constant challenge to national regulators.

 

The market can be divided into primary and secondary. The primary market is where new issues in debt or equity are arranged by investment or universal banks. New equity issues are rarer than new debt issues and once launched, will generally trade on a recognised stock exchange such as the New York or London Stock Exchange.

Debt capital markets are more diverse and include the money markets where short-term loans and deposits are traded, the foreign exchange market where currencies are bought and sold, and the long‑term debt market where bonds are bought and sold. While there is no central market such as a stock exchange for the debt markets, the debt markets will have similar infrastructure such as settlement systems, trading conventions and inter-dealer brokers.

The debt capital markets have become far more important in the last 30 years, as the role of banks has shifted from the conventional “lend and hold” approach to a model whereby banks originate loans and distribute them on the capital markets. The final holders of the securities include insurance companies, pension funds and individuals.