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DEFINITION AND EXPLANATION
CAPITAL MARKET INSTRUMENTS
CAPITAL MARKET SECURITIES
INTRODUCTION Capital markets in the United States provide the lifeblood of capitalism. Companies turn to them to raise funds needed to finance the building of factories, office buildings, airplanes, trains, ships, telephone lines, and other assets; to conduct research and development; and to support a host of other essential corporate activities. Much of the money comes from such major institutions as pension funds, insurance companies, banks , foundations, and colleges and universities. Increasingly, it comes from individuals as well. As noted in chapter 3, more than 40 percent of U.S. families owned common stock in the mid-1990s. Very few investors would be willing to buy shares in a company unless they knew they could sell them later if they needed the funds for some other purpose. The stock market and other capital markets allow investors to buy and sell stocks continuously. The markets play several other roles in the American economy as well. They are a source of income for investors. When stocks or other financial assets rise in value, investors become wealthier; often they spend some of this additional wealth, bolstering sales and promoting economic growth. Moreover, because investors buy and sell shares daily on the basis of their expectations for how profitable companies will be in the future, stock prices provide instant feedback to corporate executives about how investors judge their performance. Stock values reflect investor reactions to government policy as well. If the government adopts policies that investors believe will hurt the economy and company profits, the market declines; if investors believe policies will help the economy, the market rises. Critics have sometimes suggested that American investors focus too much on short-term profits; often, these analysts say, companies or policy-makers are discouraged from taking steps that will prove beneficial in the long run because they may require short-term adjustments that will depress stock prices. Because the market reflects the sum of millions of decisions by millions of investors, there is no good way to test this theory. In any event, Americans pride themselves on the efficiency of their stock market and other capital markets, which enable vast numbers of sellers and buyers to engage in millions of transactions each day. These markets owe their success in part to computers, but they also depend on tradition and trust -- the trust of one broker for another, and the trust of both in the good faith of the customers they represent to deliver securities after a sale or to pay for purchases. Occasionally, this trust is abused. But during the last half century, the federal government has played an increasingly important role in ensuring honest and equitable dealing. As a result, markets have thrived as continuing sources of investment funds that keep the economy growing and as devices for letting many Americans share in the nation's wealth. To work effectively, markets require the free flow of information. Without it, investors cannot keep abreast of developments or gauge, to the best of their ability, the true value of stocks. Numerous sources of information enable investors to follow the fortunes of the market daily, hourly, or even minute-by-minute. Companies are required by law to issue quarterly earnings reports, more elaborate annual reports, and proxy statments to tell stockholders how they are doing. In addition, investors can read the market pages of daily
newspapers to find out the price at which particular stocks were traded during the previous trading session. They can review a variety of indexes that measure the overall pace of market activity; the most notable of these is the Dow Jones Industrial Average (DJIA), which tracks 30 prominent stocks. Investors also can turn to magazines and newsletters devoted to analyzing particular stocks and markets. Certain cable television programs provide a constant flow of news about movements in stock prices. And now, investors can use the Internet to get up-to-the-minute information about individual stocks and even to arrange stock transactions.
CAPITAL MARKETS DEFINITION Markets for buying and selling equity and debt instruments. Capital markets channel savings and investment between suppliers of capital such as retail investors and institutional investors, and users of capital like businesses, government and individuals. Capital markets are vital to the functioning of an economy, since capital is a critical component for generating economic output. Capital markets include primary markets, where new stock and bond issues are sold to investors, and secondary markets, which trade existing securities. EXPLANATION Capital markets typically involve issuing instruments such as stocks and bonds for the medium-term and long-term. In this respect, capital markets are distinct from money markets, which refer to markets for financial instruments with maturities not exceeding one year. Capital markets have numerous participants including individual investors, institutional investors such as pension funds and mutual funds, municipalities and governments, companies and organizations and banks and financial institutions. Suppliers of capital generally want the maximum possible return at the lowest possible risk, while users of capital want to raise capital at the lowest possible cost. The size of a nation’s capital markets is directly proportional to the size of its economy. The United States, the world’s largest economy, has the biggest and deepest capital markets. Capital markets are increasingly interconnected in a globalized economy, which means that ripples in one corner can cause major waves elsewhere. The drawback of this interconnection is best illustrated by the global credit crisis of 2007-09, which was triggered by the collapse in U.S. mortgage-backed securities. The effects of this meltdown were globally transmitted by capital markets since banks and institutions in Europe and Asia held trillions of dollars of these securities.
CAPITAL MARKET INSTRUMENTS Capital market instruments are responsible for generating funds for companies, corporations and sometimes national governments. These are used by the investors to make a profit out of their respective markets. There are a number of capital market instruments used for market trade, including 1. 2. 3. 4. 5. 6. Stocks Bonds Debentures Treasury-bills Foreign Exchange Fixed deposits, and others
1. 2.Stock Market :Investors and security issuers both participate in stock markets. Different sized entities participate in stock market activities, ranging from small investors to the governments, corporations, large hedge fund traders, and banks. Corporations, governments, and companies issue securities on the stock market to collect funds. The stock market acts as a platform for companies to raise money for their business and investors to invest in securities. When both the buyers and sellers in stock markets are institutions, rather than individuals, the stock market principle is more institutionalized. The emergence of this institutional investor concept has brought some improvements to stock market operations around the world. Stock markets can exist in both real and virtual arenas. Stock exchanges with physical locations carry out stock trading on trading floor. This method of conducting trading, where the traders enter verbal bids, is called open outcry. In virtual stock exchanges, trading is done online by traders who are connected to each other by a network of computers. In addition to acting as a market place for stock trading, stock markets also act as the clearinghouse for stock transactions. This means that stock exchanges collect and deliver the securities and also guarantee payment to the seller. This ensures both the buyers and sellers of securities that their counterparts will not default on the transaction. Stock markets in various countries around the world have performed well due to financial sector reforms and integration. International flow of funds has raised the expertise of stock exchanges in the respective countries.
3.Bond Market :The bond market is a financial market that acts as a platform for the buying and selling of debt securities. The bond market is a part of the capital market serving platform to collect fund for the public sector companies, governments, and corporations. There are a number of bond indices that reflect the performance of a bond market. The bond market can also b called the debt debt market, credit market, or fixed income market. The size of the current international bond market is estimated to be $45 trillion. The major bond market participants are: governments, institutional investors, traders, and individual investors. According to the specifications given by the Bond Market Association, there are five types of bond markets. They are: Corporate Bond Market Municipal Bond Market Government and Agency Bond Market Funding Bond Market Mortgage Backed and Collateralized Debt Obligation Bond Market The bonds are usually specific to individual issues and there is a lack of liquidity in the bonds. This is the reason that most of the bonds are held by institutions like banks, mutual funds, and pension funds. Bond markets are generally decentralized, and unlike stocks and futures, there exists no common exchange for the bond market. The bond market is less volatile in nature than the stock market, and thus investors purchase the bond coupon and holds it until it matures. As risk associated with bond investment is less, the return received is also less. Index There are some risks that the bond investors have to face. The change in interest rate is the major risk that occurs in bond investment. The interest rate and value of bond are inversely proportional to one another. When the rate of interest increases, the bond value falls considerably as the new issues pay a higher yield. Conversely, when the interest rate decreases, the bond value rises. The interest rate fluctuation may depend on the volatility of the bond market and also on the monetary policy of the country The bond market indices consist of bond listings, and they are a tool to mirror the performance of a particular security. Bond indices may vary with the type of the bonds. There are different indices for government bonds, high-yield bonds, corporate bonds, and mortgage-backed securities. Debentures
Debentures are long-term Debt Instrument, which is not backed by Collaterals. Debentures are unsecured debt backed by the creditworthiness and reputation of the Debenture issuer and documented by an agreement called an indenture. Debentures are issued usually by large, financially strong companies with excellent bond ratings. One example of debenture is an unsecured bond. Debentures are long-term Debt Instrument issued by governments and big institutions for the purpose of raising funds. Debentures have some similarities with Bonds but the terms and conditions of securitization of Debentures are different from that of a Bond. A Debenture is regarded as an unsecured investment because there are no pledges (guarantee) or liens available on particular assets. Nonetheless, a Debenture is backed by all the assets which have not been pledged otherwise. Normally, Debentures are referred to as freely negotiable Debt Instruments. The Debenture holder functions as a lender to the issuer of the Debenture. In return, a specific rate of interest is paid to the Debenture holder by the Debenture issuer similar to the case of a loan. In practice, the differentiation between a Debenture and a Bond is not observed every time. In some cases, Bonds are also termed as Debentures and viceversa. If a bankruptcy occurs, Debenture holders are treated as general creditors. The Debenture issuer has a substantial advantage from issuing a Debenture because the particular assets are kept without any encumbrances so that the option is open for issuing them in future for financing purposes. 4.Treasury Bills :Treasury Bills, also known as "T-Bills," are bonds that are issued by the US government, making them important both to the American economy and the world of finance. Although many people think The United States Department of Treasury is responsible for issuing these, they are actually issued by the Bureau of Public Department. Treasury Securities come in four separate denominations: Treasury Bills, Notes, Bonds, and Savings Bonds. Second to Savings Bonds, they are the most popular in the various secondary markets and easy options to use. These bills do not yield any interest before they mature. They are usually sold at discounts on their respective face values. In that respect they are like zero-coupon bonds. At the time of maturity the consumer is rewarded with positive returns. Investors in the US consider these Bills to be the safest forms of investment. The average term periods range from 28 days to 91 with a maximum of 130 days. Financial organizations like banks and primary dealers are the biggest consumers of T-Bills. 5.Foreign Exchange (Forex) Market :Foreign Exchange Market or Forex market is a place where international currencies are traded. It has emerged to be the largest and decentralized financial market operating globally.
It does not have any central authority and hence it is called an "Over The Counter" (OTC) market. It allows the traders to buy, sell, exchange and speculate on currencies. The major determinant of the exchange rate is the monetary value of the currency. 6.Forex Market - A Global Entity: It is after the breakdown of Bretton Woods system in 1971 and most of the economies shifting to managed exchange rate regime, when the forex market started operating globally in a major way. It is after the breakdown of Bretton Woods system in 1971 and most of the economies shifting to managed exchange rate regime, when the forex market started operating globally in a major way. The decade of 1990's witnessed major policy changes thereby re-orienting markets which reflected a rapid expansion of forex market in terms of: Increased number of participants Increased transaction volumes Decline in transaction costs Efficient mechanisms of risk transfer The forex market is the most liquid market in the world now and accounted for almost $4 trillion as daily turnover in 2010 Forex Market Participants: The Forex market is different from stock market in the sense that the former follows a hierarchical order in its level of access. At the apex is the Inter-Bank market, consisting of commercial banks and security dealers. They account for 53 % of all transactions. Following Inter-Banks are the Smaller Banks, then the Multi National Corporations, large Hedge Funds and some Retail Forex market makers. Hence, the main participants are: Banks Forex fixing Central banks Retail forex traders Commercial companies Hedge funds as speculator Non-banking forex companies Investment management firms Money transfer/Remittance companies
As the forex market follows OTC nature of market, the exchange rates (prices) of different currencies are not fixed. The price of a currency depends on the trading banks or market makers. The quoted price of any currency reflects London's market price, as it is the main trading centre in the world. Factors Influencing Forex Market: The changes in the forex market are a cumulative effect of economic factors, political conditions and market psychology. Economic factors: The economic policies, balance of trade as well as inflation and growth rates of an economy influence the exchange rate of a currency. An economy's productivity also influences its exchange rates positively. Political conditions: Political stability is one of the key factors operating behind forex market fluctuations. Also events in one country may affect the exchange rate of neighboring country's currency. Market psychology: Forex markets are highly responsive to expectations and market perceptions. The participants often rely their decisions on long term trends of economic indicators. Currencies Traded: The most traded currencies in the forex market are: 1. U.S Dollar (USD) 2. British Pound Sterling (GBP) 3. Euro (EUR) 4. Canadian Dollar (CAN) 5. Australian Dollar (AUD) 6. Swiss Franc (CHF) 7. New Zealand dollar (NZD) 8. Japanese Yen (JPY) As measured by the volumes of trade, USD-GBP and USD-EUR are the most popular currency pairs. However, this does not imply that they are the most profitable currency pairs or best investment options. It is always advisable that any customer should analyze past data for the currency pair with greatest pip movement and least volatility before making investment decisions. 7.Public Deposits :-
The public deposits refer to the deposits that are attained by the numerous large and small firms from the public. The public deposits are generally solicited by the firms in order to finance the working capital requirements of the firm. The companies offer interest to the investors over public deposits. The rate of interest, however, varies with the time period of the public deposits. The companies generally offer 8 to 9 percent interest rate on the deposits made for one year. The companies offer 9 to 10 percent interest rate over public deposits for two years while 10 to 11 percent interest rate is offered for the three year deposits. There are rules regulating the fixed deposits. According to the Companies Amendment Rules 1978, here is the list of rules for public deposits: The maximum maturity period for a public deposit is 3 years The minimum maturity period for public deposits is 6 months The maximum maturity period for a public deposit for Non-Banking Financial Corporation is 5 years The public deposits of a company cannot go past 25% of free reserves and share capitals The companies asking for public deposits need to publish information regarding the position and financial performance of the firm The companies having public deposits need to keep aside the 10% of the deposits by 30th April every year that will mature by 31st March next year. The various advantages of public deposits enjoyed by the companies are: There is no involvement of restrictive agreement The process involved in gaining public deposit is simple and easy The cost incurred after tax is reasonable Since there is no need to pledge security for public deposits, the assets of firm that can be mortgaged can be preserved The disadvantages of public deposits from the company's point of view are: The maturity period is short enough Limited fund can be obtained from the public deposits The advantages of public deposits enjoyed by the investors are: The interest rate is higher than the other financial investment instruments
The fund maturity period is short The disadvantages of public deposits from the investors' pint of view are: The interest that is charged on the public deposits does not enjoy tax exemption There is no pledging of security against public deposits.
Capital market is also known as Securities Market because long term funds are raised through trade on debt and equity securities. These activities may be conducted by both companies and governments. This market is divided into: primary capital market and secondary capital market. The primary market is designed for the new issues and the secondary market is meant for the trade of existing issues. Stocks and bonds are the two basic capital market instruments used in both the primary and secondary markets. There are three different markets in which stocks are used as the capital market instruments: the physical, virtual, and auction markets. Bonds, however, are traded in a separate bond market. This market is also known as a debt, credit, or fixed income market. Trade in debt securities is done in this market. These include: the T-bills and Debentures. These instruments are more secure than the others, but they also provide less return than the other capital market instruments. While all capital market instruments are designed to provide a return on investment, the risk factors are different for each and the selection of the instrument depends on the choice of the investor. The risk tolerance factor and the expected returns from the investment play a decisive role in the selection by an investor of a capital market instrument. The instruments should be selected only after doing proper research in order to increase one.
CAPITAL MARKET SECURITIES Stocks and bonds are generally termed as the capital market securities. These are traded in separate markets. These capital market securities are used by a number of companies, corporations and governments to raise funds for various purposes. These funds are raised for long terms. There are the regulatory authorities in every country to supervise the capital market securities and their respective market. The bond market is a part of the capital market and provides the opportunity to deal in the debt securities. Bond is the medium of dealing in the debt securities. As one of the capital market securities, bond enjoys a vast international market which is estimated around $45 trillion. A huge portion of this bond market transaction generally takes place in the over-the-counter market. On the other hand, the corporate bonds are listed on the exchanges. There are different types of bonds available in the market like the corporate bond, The municipal bond, the government bond and many more. Among all these capital market securities, the government bond is the most secured one. The government bond market is very big and its liquidity is also beyond comparison. Another important capital market securities is known as stocks. These are preferred by the investors because an investor can get huge returns from this capital market instrument. The stock market is used for trading of company stocks, other securities and derivatives. $45 trillion is the estimated size of the global stock market. This market is used by the companies to raise funds for different purposes. At times, the governments also turn towards the stock market to generate funds. The market participants include every kind of investor. There are both the individual investors and the institutional investors who are taking part in the market. In the past, there were only the individual investors in the market but the market trend has completely changed and todays market is mainly dominated by the institutions which in turn, is increasing the volume of the market. The investor should take proper care while selecting the capital market securities because the risk factor related to these securities are different. At the same time, the returns may also vary. So a proper research should be done before investment.
PRIMARY CAPITAL MARKET The capital market is divided in two different markets. These are the primary capital market and secondary capital market. The primary capital market is concerned with the new securities which are traded in this market. This market is used by the companies, corporations and the national governments to generate funds for different purpose. The primary capital markets is also called the New Issue Market or NIM. The securities which are introduced in the market are sold for first time to the general public in this market. This market is also known as the long term debt market as the money raised from this market provides long term capital.The process of offering new issues of existing stocks to the purchasers is known as underwriting. At the same time if new stocks are introduced in the market, it is called the Initial Public Offering. The act of selling new issues in the primary capital market follows a particular process. This process requires the involvement of a syndicate of the securities dealers. The dealers who are running the process get a certain amount for as commission. The price of the security offered in the primary capital market includes the dealer,s commission also.Again, if the issue is a primary issue, the investors get the issue directly from the company and no intermediary is needed in the process. For the purpose, the investor needs to send the exact amount of money to the respective company and after receiving the money, the particular company provides the security certificates to the investors. The primary issues which are offered in the primary capital market provide the essential funds to the companies. These primary issues are used by the companies for the purpose of setting new businesses or to expanding the existing business. At the same time, the funds collected through the primary capital market, are also used for the modernization of the business. At the same time, the primary capital market is also involved in the process of creating capital for the respective economy. There are three ways of offering new issues in the primary capital market. These are: Initial Public Offering Preferential Issue. Rights Issue (For existing Companies).
SECONDARY BOND MARKET The secondary bond markets play a marketplace for the bonds that are already issued in the primary market. The secondary debt market deals with the debts and hence is also known as the debt or credit market. The secondary bonds market handles the reselling of bonds by investors. The money that is paid for bonds in the secondary market goes to other investors but not to the issuers. On the other hand in case of the primary market the money paid by the investors goes directly to the issuer companies. When the investors purchase bonds, they can either hold it until its maturity date. The investor can thus receive regular interest payments and the principal as well at its maturity. On the other hand, the investor can also sell it before the maturity date in the secondary bond market. The new owner of the bond now will be eligible to receive the regular interest payments and also the principal at the end of bond's maturity period. The resale value of a bond in the secondary markets differs from that of the face value. The resale value of the bond is based on the interest rate of the day when the transaction is carried out. With the rise or fall of the interest rate, the value of bond also rises or falls accordingly. Trading in the secondary bond market is important for both the capital market and economy. Hence it is necessary that the secondary market be highly transparent and liquid in nature. The corporations, governments and companies issue bonds and stocks in the capital market in order to collect fund. But it is primary bond market from where the companies can collect the fund. The money collected from the selling bonds in primary market goes directly to the company. But in case of the secondary market, an investor or speculator sells the bonds and the money goes to another investor in stead of the company. The secondary bond market trend gives idea about the market liquidity of a particular bond. The investor can either hold the bond for a long period of time or sell it after a short period of time. But it has been seen that the investors are not very interested to invest in the long-term bonds.
PRIMARY VS. SECONDARY MARKET A study on the primary vs. secondary market gives information on the various aspects of the capital market trading. Both the primary market and secondary market are two types of capital market depending on the issuance of securities. Primary Market - Definition: The primary markets deal with the trading of newly issued securities. The corporations, governments and companies issue securities like stocks and bonds when they need to raise capital. The investors can purchase the stocks or bonds issued by the companies. Money thus earned from the selling of securities goes directly to the issuing company. The primary markets are also called New Issue Market (NIM). Initial Public Offering is a typical method of issuing security in the primary market. The functioning of the primary market is crucial for both the capital market and economy as it is the place where the capital formation takes place. Secondary Market - Definition: The secondary market is that part of the capital market that deals with the securities that are already issued in the primary market. The investors who purchase the newly issued securities in the primary market sell them in the secondary market. The secondary market needs to be transparent and highly liquid in nature as it deals with the already issued securities. In the secondary market, the value of a particular stock also varies from that of the face value. The resale value of the securities in the secondary market is dependant on the fluctuating interest rates. Primary vs. Secondary Market: Primary vs. secondary market says that the primary market deals with the newly issued securities while the secondary market deals with already traded securities. When the companies issue securities in the primary market, they collect funds directly from the investors through the securities sales. But, in the secondary market the money earned from selling a security does not go to the company. The money thus earned goes to the investor who sells the security.
GLOBAL CAPITAL MARKET The global capital market is gaining depth everyday. Along with the development of this market, the liquidity is also growing at a rapid pace. Several surveys have shown that financial stocks are growing worldwide and their growth rate is much higher than that of global gross domestic products. Capital market represents the securities market where stocks, bonds, and several other derivatives are traded, and both long and short-term debts are raised here. This market provides companies, as well as governments with necessary funding, and, simultaneously, grants investors with the opportunity to make regular income. The development of the global capital market can also be traced by the fact that the financial holdings of the world is growing quickly- it is estimated to be somewhere around $140 trillion, and this amount is expected to cross the $200 mark before the end of 2010. With the emergence of the concept of globalization, the diversified world market has been transformed into a single market, which has resulted in the promotion of inter-country trade. Because of this, there has been an increase in stature and an increase in capital flow, of which the United States of America, Europe and Britain share almost 90%. In these circumstances, the US is playing a vital role in the development of the global capital market and, alone, is the destination of 85% of the net capital flow of the entire globe. Britain also plays a significant role in the market. On the other hand, because of the rapid transformation of the Eurozone, its emergence as a financial power is causing positive changes. This could shift the pillars of the world economy, as the Eurozone is expected to soon stand on the same financial platform with its counterparts.
VENTURE CAPITAL MARKET Venture Capital is an age old concept but the Venture Capital Market has developed in the recent decades. The term venture capital denotes the act of investment in the areas of high risk, in order to get some high returns. The developments in the venture capital market has taken place in the US markets mainly. The market of venture capital, in the past, was disconnected and may be identified as individualized to some extent. In the recent times only, the market has been shaped and the market became matured. Venture Capital Markets are a boon for those who want to set up new business. At the same time, if an existing business wants to develop, the venture capitalists are there to provide financial assistance. These capitalists have their own business interest behind the assistance. These people want to have a share of the huge profits by the business in the future. Because of this, only those businesses are selected which are supposed to develop rapidly in the future. For this purpose, the venture capitalists have their own team of people to identify the appropriate opportunities. The modern concept of venture capital should be grateful to General Doriot because he was the person who founded the American Research and Development Fund. This was done to provide financial assistance to the activities of developing new technologies in the US universities. At the same time, the commercial use and financial benefits from such technologies were also considered seriously. With the commercial success of the concept of venture capital, big players entered the venture capital market of United States of America. The giant companies like Xerox and General Electric played a major role in expanding the venture capital market. The entry of these companies in this market with separate divisions to deal in the market, encouraged many others. Because of these situations, the venture capital market was expanded beyond the territories of the US and within a short period, it gained ground globally.
EQUITY CAPITAL MARKET The equity capital market is an important part of the capital market. In this market, companies and financial institutions raise funds and provide equities using the shares of their own businesses. Investors invest in the company by purchasing the shares or equities. Company stocks are the prime financial instrument of the equity capital market. This instrument is provided and maintained by the companies or the financial institutions themselves. The reputation of the stocks in the equity capital market is largely dependent on the companies themselves, because the it is maintained by different types of financial data provided by the companies. The provided data helps the investor understand the present position and the future of the company in the equity capital market. When the investor is satisfied, he or she makes the investment and the money grows with the company. In certain situations, the result may not be beneficial to the investor. The companies also provide regular dividends to these investors. Participants in the equity capital market range from huge companies to small individual investors. In the past, wealthy individuals dominated the market, but market trends are different now. The introduction of institutional investors has improved the market, and today they are playing the dominant role. In addition to different types of company stocks, the equity capital market provides financial instruments known as derivatives. Futures, swaps and options are among these derivatives. The value of these instruments derives from the equities themselves. The equity capital market and the debt capital market together form the capital market. The primary difference between the equity capital and debt capital markets is the amount of risk and return related to them. The equity capital market is known for its huge returns and its high risks. On the other hand, the debt capital market is far more secure than the equity market but the returns are low.
DEBT CAPITAL MARKET Debt Capital Market is a market for trading debt securities where business enterprises (companies) and governments can raise long-term funds. This includes private placement as well as organized markets and exchanges. The debt capital market trades in such financial instruments which pays interest. There are the bonds and several loans which act as the prime financial instrument of this market. Because of this interest factor, the debt capital market is also known as fixed income market. Debt capital market and equity market jointly makes the capital market. These markets are used by the governments and several companies for raising funds for long and short term. The trade in these markets is done through several financial instruments. Financial regulators, such as the UK's Financial Services Authority (FSA) or the U.S. Securities and Exchange Commission (SEC), oversee the capital markets in their designated jurisdictions to ensure that investors are protected against fraud, among other duties. Debt capital is funds supplied by lenders that are part of a firm's capital structure. Debt capital usually refers to long-term capital, specifically bonds, rather than short-term loans to be paid off within one year. If the short-term debt is continually rolled over, however, it can be considered relatively permanent and thus debt capital. Debt capital has advantages and disadvantages over equity, the other component of a company's capital structure. The regular interest payments for debt capital represent a cost of doing business and, unlike dividends, are tax deductible. Debt capital also enables the firm to expand its profits indefinitely, provided it can make a greater return on the debt capital than the costs of servicing it. However, unlike dividends, interest payments to bondholders must be met on time and in full. Furthermore, as debt becomes a greater part of the firm's capital structure, a downturn in business threatens the company's survival, as the costs of servicing debt capital mount. Financial analysts thus spend much effort trying to determine the best proportion of debt capital in a company's capital structure. Bonds are of several types like the government bonds, the municipal bonds, corporate bonds and many more. By investing in these bonds, the investors actually provide loan to the respective organization or to the government. These loans are provided for some fixed interest rate which the company or the organization provides to the investor at regular intervals. The modern concept of venture capital should be grateful to General Doriot because he was the person who founded the American Research and Development Fund. This was done to provide financial assistance to the activities of developing new technologies in the US universities. At the same time, the commercial use and financial benefits from such technologies were also considered seriously. With the commercial success of the concept of venture capital, big players entered the venture capital market of United States of America. The giant companies like Xerox and General Electric played a major role in expanding the venture capital market.
The entry of these companies in this market encouraged with separate divisions to deal in the market encouraged many others. Because of these situations, the venture capital market was expanded beyond the territories of US and within a short period, it gained ground globally.
CAPITAL MARKET THEORY Capital Market Theory tries to explain and predict the progression of capital (and sometimes financial) markets over time on the basis of the one or the other mathematical model. Capital market theory is a generic term for the analysis of securities. In terms of trade off between the returns sought by investors and the inherent risks involved, the capital market theory is a model that seeks to price assets, most commonly, shares. In general, whenever someone tries to formulate a financial, investment, or retirement plan, he or she (consciously or unconsciously) employs a theory such as arbitrage pricing theory, capital asset pricing model, coherent market hypothesis, efficient market hypothesis, fractal market hypothesis, or modern portfolio theory. The most talked about model in Capital Market Theory is the Capital Asset Pricing Model. In studying the capital market theory we deal with issues like the role of the capital markets, the major capital markets in the US, the initial public offerings and the role of the venture capital in capital markets, financial innovation and markets in derivative instruments, the role of securities and the exchange commission, the role of the federal reserve system, role of the US Treasury and the regulatory requirements on the capital market. The Capital Market Theory deals with the following issues: Importance of venture capital in the capital market Initial public offerings Role of capital market Major capital markets worldwide Markets and financial innovations in derivative instruments Role of Federal Reserve System Role of securities Capital market regulatory requirements Role of the government treasury Assumptions of Capital Market Theory The capital market theory builds upon the Markowitz portfolio model. The main assumptions of the capital market theory are as follows: 1.All Investors are Efficient Investors: Investors follow Markowitz idea of the efficient frontier and choose to invest in portfolios along the frontier.
2.Investors Borrow/Lend Money at the Risk-Free Rate: This rate remains static for any amount of money. 3.The Time Horizon is equal for All Investors: When choosing investments, investors have equal time horizons for the chosen investments. 4.All Assets are Infinitely Divisible: This indicates that fractional shares can be purchased and the stocks can be infinitely divisible. 5.No Taxes and Transaction Costs: It is assumed that investors results are not affected by taxes and transaction costs. 6.All Investors Have the Same Probability for Outcomes: When determining the expected return, assume that all investors have the same probability for outcomes. 7.No Inflation Exists: Returns are not affected by the inflation rate in a capital market as none exists in capital market theory. 8.There is No Mispricing within the Capital Markets: It is assumed that the markets are efficient and that no mispricings within the markets exist. Mortgages, equities, bonds, and other investments are traded in the capital market. The financial instruments in this market have long maturity periods. Capital market theory states that federal funds, federal agency securities, treasury bills, commercial papers, negotiable certificates of deposits, repurchase agreements, Eurocurrency loans and deposits, options and futures are merchandised in the capital market. When one has to put a price on a security, one has to determine the risk and return of the security both for single assets, as well as a portfolio of assets. The uncertainty and variability of returns on assets and the possibilities of losses can be defined as risks. The theory of capital market defines returns in the following manner: K = Pt + Ct - Pt-1 / Pt-1 Where the time of purchase of the asset of price Pt-1 is t-1. If this be the case, then the return (K) from the time period t-1 to t is the above mentioned formula. Ct is the cash gotten from assets between t-1 and t. Pt is the price of the asset at time t. For practitioners of the capital market theory, it has not lost its significance. It is still as important for retirement, financial, and investment plans. Capital Market Assumptions Asset allocation is one of the most important decisions related to investment in the capital market. There are a number of risk factors related to these investments, and because of this appropriate capital market analyses are necessary.
There are firms which provide capital market investment solutions to investors, each making their own risk and return calculations, or capital market assumptions. These assumptions are followed strictly when making suggestions to the clients regarding the asset allocation. Many companies also provide their clients with their capital market assumptions so that the clients can evaluate their own investment decisions. Of course, capital market assumptions cannot be permanent and thus need to be changed from time to time. The market prices of different investment instruments change very rapidly, and with this rapid change the level of risk also changes. Different consultation companies use different techniques to get their perfect capital market assumptions. However, most companies concentrate on valuations because they can provide the most accurate capital market assumptions for the future. Other factors useful in making capital market assumptions are the ratio between the price and earning of the particular asset, the dividend yield, the interest rates, and the growth rate of the assets. Apart from the internal factors of the capital market, there are also macroeconomic trends that are related to making capital market assumptions. These include the level of inflation, changes in the Gross Domestic Product (GDP), and increases or decreases in the unemployment rate. International external factors related to the capital market which play a major role in shaping capital market assumptions too include taxation, foreign denominations, and decisions of national regulators.
CAPITAL MARKET RISK The capital market risk usually defines the risk involved in the investments. The stark potential of experiencing losses following a fluctuation in security prices is the reason behind the capital market risk. The capital market risk cannot be diversified. The capital market risk can also be referred to as the capital market systematic risk. While an individual is investing on a security, the risk and return cannot be separated. The risk is the integrated part of the investment. The higher the potential of return, the higher is the risk associated with it. The examination of the involved in the capital market investment is the one of the prime aspects of investing. It can be easily said that the risk distinguishes an investment from the savings. The systematic risk is also common to the entire class of liabilities or assets. Depending on the economic changes the value of investments can fall enormously. There may be some other financial events also impacting the investment markets. In order to give a check to the capital market risk, the asset allocation can be fruitful in some cases. Any investment in stocks or bonds comes with the following types of risks. Market Risk Industry Risk Regulatory Risk Business Risk The market risk defines the overall risk involved in the capital market investments. The stock market rises and falls depending on a number of issues. The collective view of the investors to invest in a particular stock or bond plays a significant role in the stock market rise and fall. Even if the company is going through a bad phase, the stock price may go up due to a rising stock market. While conversely, the stock price may fall because the market is not steady even if the investor's company is doing well. Hence, these are the market risks that the stocks investors generally face. The industry risk affects all the companies of a certain industry. Hence the stocks within an industry fall under the industry risk. The regulatory risk may affect the investors if the investor's company comes under the obligation of government implemented new regulations and laws. The business risk may affect the investors if the company goes through some convulsion depending on management, strategies, market share and labor force.
ROLE OF CAPITAL MARKET The primary role of the capital market is to raise long-term funds for governments, banks, and corporations while providing a platform for the trading of securities. This fundraising is regulated by the performance of the stock and bond markets within the capital market. The member organizations of the capital market may issue stocks and bonds in order to raise funds. Investors can then invest in the capital market by purchasing those stocks and bonds. The capital market, however, is not without risk. It is important for investors to understand market trends before fully investing in the capital market. To that end, there are various market indices available to investors that reflect the present performance of the market. Regulation of the Capital Market Every capital market in the world is monitored by financial regulators and their respective governance organization. The purpose of such regulation is to protect investors from fraud and deception. Financial regulatory bodies are also charged with minimizing financial losses, issuing licenses to financial service providers, and enforcing applicable laws. The Capital Market’s Influence on International Trade Capital market investment is no longer confined to the boundaries of a single nation. Today’s corporations and individuals are able, under some regulation, to invest in the capital market of any country in the world. Investment in foreign capital markets has caused substantial enhancement to the business of international trade. The Primary and Secondary Markets The capital market is also dependent on two sub-markets – the primary market and the secondary market. The primary market deals with newly issued securities and is responsible for generating new long-term capital. The secondary market handles the trading of previously-issued securities, and must remain highly liquid in nature because most of the securities are sold by investors. A capital market with high liquidity and high transparency is predicated upon a secondary market with the same qualities.
CAPITAL MARKET INVESTMENT A capital market is a market where both The capital market investment makes the investors to buy or sell securities in the capital markets. The stock market and bond market are types of capital markets where investors can trade in stocks and bonds. The investments in the capital market may be either in the bonds or stocks. Investments in the stocks or bonds may be either investing in the new issues or in the existing securities. The primary capital market handles the trading and investments in the new issues while the secondary capital market takes care of the trading of existing securities. There are a number of financial regulators that monitor the capital market dealings in order to protect the investors from fraud. U.S. Securities and Exchange Commission is one such financial regulator that regulates the capital markets situated in their designated countries for the best interest of the investors. Stock Investment The investment in stocks may in six different styles. Depending on the needs and reasons of the investors, the efficiency of the investment is estimated. There are some investors who depend on the advice of other people while purchasing or selling a particular stock. There are technical investors who spend time in studying the stock patterns before trading any stock. The economist investors take their decision of stock trading depending on the economic forecasts. They are in the nature to take risks and get benefited in return following an efficient market hypotheses. There are some other types of investors who rely on the information given by the researchers, vendors and trade executives to make investment in the stocks. There are value investors who try to value the stock independently of its market price. Finally, there are conscious investors who depend on their own measurements and beliefs while making any stock investment. Bond Investment Bond investment is different from that of stock investment. Bond investment is investing in the debt instrument that is issued by a company or government. The bond investor is actually lending money to the company while in return is promised to be paid the full principal amount plus a fixed periodic payout. The yield on the bond is calculated by putting together the final principal and total payouts received. The yield is the effective interest rate for the tenure of the bond.
EFFICIENT CAPITAL MARKET An efficient capital market is a market where the share prices reflect new information accurately and in real time. Capital market efficiency is judged by its success in incorporating and inducting information, generally about the basic value of securities, into the price of securities. This basic or fundamental value of securities is the present value of the cash flows expected in the future by the person owning the securities. The fluctuation in the value of stocks encourage traders to trade in a competitive manner with the objective of maximum profit. This results in price movements towards the current value of the cash flows in the future. The information is very easily available at cheap rates because of the presence of organized markets and various technological innovations. An efficient capital market incorporates information quickly and accurately into the prices of securities. In the weak-form efficient capital market, information about the history of previous returns and prices are reflected fully in the security prices; the returns from stocks in this type of market are unpredictable. In the semistrong-form efficient market, the public information is completely reflected in security prices; in this market, those traders who have non-public information access can earn excess profits. In the strong-form efficient market, under no circumstances can investors earn excess profits because all of the information is incorporated into the security prices. The funds that are flowing in capital markets, from savers to the firms with the aim of financing projects, must flow into the best and top valued projects and, therefore, informational efficiency is of supreme importance. Stocks must be efficiently priced, because if the securities are priced accurately, then those investors who do not have time for market analysis would feel confident about making investments in the capital market. Eugene Fama was one of the earliest to theorize capital market efficiency, but empirical tests of capital market efficiency had begun even before that.
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