Definition and Scope
Capital markets generally refer to stock and bond markets, as in the market for long-term financing. These are markets where companies and governments issue stocks and bonds to finance their long-term investments and growth. A career typically requires a long time horizon for the use of the funds; therefore, invest on net future return (since more like saving) than annual returns. The sum of the global capital market in 2023 was around $95 trillion. Not only that world’s combined stock market is close to $55 trillion, and its total bond markets add up to about $40 trillion.
Whereas, the financial markets are a more comprehensive space of all primary and secondary markets facilitating the flow or transfer of funds directly between banks. Money Markets, Capital Markets, and Foreign Exchange markets are examples of financial markets, along with many others like Derivatives Markets. In 2023, The total volume of global financial markets has even exceeded $350 trillion. In simple terms, financial markets are larger market systems that do not only include the activities of long-term financing but also involve short-term fund flows and many foreign exchange transactions.
Functions and Purposes
Capital markets exist to provide companies and governments with long-term money. Companies raise money that does not need to be repaid by issuing shares, while bonds are long-term infrastructure loans for governments and large companies. These funds are primarily employed for capital investment, including infrastructure building and R&D investments, as well as reorganization (such as mergers). In 2022, global IPO financing raised more than $3.2 trillion through stock markets, and the issuance volume in the bond market had over $8.6 trillion, as stated by the International Monetary Fund (IMF)
Financial markets have a broad role in long-term financing and short-term finance inter-administration (risk management), control of liquidity, and foreign exchange trading. Money markets, estimated at $30 trillion in 2023, are used by companies and governments for short-term funding. Globally, about $2.7tn of notional outstanding derivatives contracts change hands daily through the markets. These contracts are where companies and investors go to hedge market exposures. The foreign exchange market, with a daily turnover of $ 7.5 trillion, is the largest in terms of global trading volume among all financial subsystems, and it is primarily used to support cross-border trade and wealth formation.
Market Participants
Corporates, governments and the like are on one side of the equation, while institutional investors and individual capital market participants are on the other end. Indeed, in capital markets, they normally are the lowest common denominator for institutional investors. Global Asset Management Company Rankings 2023 Based on the wealth, Owen I with data shows that in total, managed assets size of only ten global asset management companies for more than $35 trillion to account for greater than 35% of the world’s capital markets.
The financial markets are a complex and dynamic ecosystem, with a multitude of players influencing its trajectory. Beyond the institutional investors and individual participants, there are numerous other entities such as commercial banks, central banks, hedge funds, individual investors, investment banks, and currency-speculation companies. The ten largest global hedge funds manage a combined asset pool of over 1.5 trillion dollars, while central banks effectively manage at least 12-13 superglobal foreign exchange reserves, each exceeding a total value of US$12.500bn/2023.
Trading Products and Instruments
Major capital market products are, e.g., stocks, bonds and derivatives based on these underlying product types (stock options or bond futures). The price may be influenced by many factors particular to the product, such as its supply and demand or perhaps a company’s financial status. The typical price-earnings ratio of S&P 500 index constituents stood at a record-high for this time last year of around 22 times, effectively pricing in expectations for profit growth ahead.
Financial markets play a crucial role in providing a wide array of products and instruments. These include currency and foreign exchange, commodity futures (such as Stocks and bonds), financial derivatives, future interest rates, and swaps. The distinction between OTC and exchange-traded markets is also significant. The notional value of the global OTC derivative market was 640 trillion in 2023. This diversity of products in financial markets enables investors and institutions to select instruments with their desired risk profile based on their trading or investment goals.
Risk Characteristics
The risks in capital markets, primarily market risk and credit risk, are not to be taken lightly. Market risk, which captures the potential investment losses due to stock and bond price changes, was starkly illustrated in the 2020 pandemic when global stock markets crashed down over 30%. This volatility can have a significant impact on investments, making it crucial to be concerned and attentive. Credit risk, on the other hand, is the investor’s chance to see its bond issuer fail to pay principal and interest in a timely manner. The global corporate bond default rate was approximately 2.5% in the year 2022, as per Moody’s data, further emphasizing the potential impact of these risks on financial products and investments.
