The capital market

Having discussed what financial system is, then there is the need to go further by touching the various components of the system. Therefore this post will be focusing on capital market which together with the money market makes up the important component of the financial system known as financial market.

Therefore, capital markets are financial markets for the buying and selling of long-term debt or equity-backed securities. These markets channel the wealth of savers to those who can put it to long term productive use, such as companies or governments making long-term investments In another perspective, capital market is a market in which financial securities such as stocks, bonds and government loan instrument are bought and sold. Corporate entities and governments therefore, use capital market to raise funds for their operations and programmes respectively. For example, a company may float an initial public offer while a government may issue bond or development loan stock to raise funds for new projects or ongoing public programmes Investors purchase securities (stocks or bonds) in the capital markets in order to extract some returns or earn profits on their investment. Capital markets include primary markets, for the initial public offers of securities that are placed with investors through issuing houses and underwriters, and secondary markets, in which all subsequent trading on existing securities takes place.  

Financial regulators, such as the UK's Bank of England (BoE) or the U.S. Securities and Exchange Commission (SEC), oversee the capital markets in their jurisdictions to protect investors against fraud, among other duties. The Nigerian Securities and Exchange Commission also perform the same function


Transactions in modern capital markets are almost invariably carried out based on computer-operated electronic trading systems; most can be accessed only by entities within the financial sector or the treasury departments of governments and corporations, but some can be accessed directly by the public.  

There are many thousands of such systems, most only serving only small parts of the overall capital markets. Entities hosting the systems include stock exchanges, investment banks, and government departments. Physically the systems are hosted all over the world, though they tend to be concentrated in financial hubs or centres such as Lagos, London, New York, and Hong Kong, among others  

There is an important division between the stock markets mainly for equity securities, in form of shares, which investors purchase for the purpose of having ownership interest in the companies that float such securities. The other is the bond markets which cater for creditors when they subscribe to the securities floated by companies for raising funds on the basis of debts that have maturity dates before they are repaid back to the holders.  

Operations of a Capital Market
In respect of the operations of the capital market, there are different players that are active in the secondary segment of the market. Such players include the following.

Regular individual investors
These participants in the market account for a small proportion of trading, though their share still plays some significant role in the market. A few wealthy individuals who could afford an account with a broker, but transactions are now much cheaper and accessible over the internet.  

Traders
These are the jobbers and stock brokers. The jobbers in highly developed capital markets operate by buying securities with the intention of making profits. The do not transact business on behalf of any investors but behave like real traders who engage in buying and selling of capital market securities.

The profit earned by the jobbers is called the jobbers turn. On the other hand, the stock brokers transact business on behalf of investors who pay commission on volume of transactions done for them by the stockbrokers. There are numerous small traders who can buy and sell securities on the secondary markets using platforms provided by brokers which are accessible through electronics means such as with web browsers. When such an individual trades on the capital markets, it will often involve a two stage transaction.  

First they place an order with their broker, on the strength of which the broker executes the trade. If the trade can be done on an exchange, the process will often be fully automated. If a dealer needs to manually intervene, this will often mean a larger fee.  

Investment banks
Traders in investment banks will often make deals on their bank's behalf, as well as executing trades for their clients. Investment banks will often have a department called capital markets. Staff in such department try to keep abreast of the various opportunities in both the primary and secondary markets, and will advise major clients accordingly.  

Pension and Sovereign Wealth Funds  
These players tend to have the largest holdings, though they tend to buy only the highest grade securities which are safest types of bonds and shares, and often don't trade all that frequently.  

Hedge funds  
These are increasingly making most of the short-term trades in large sections of the secondary markets of advanced economies such as the UK and US stock exchanges, which is making it harder for them to maintain their historically high returns, as they are increasingly finding themselves trading with each other rather than with less sophisticated investors.

Divisions in the Capital market .
The capital market is divided into two sectors depending on the type of issues they deal in and they are as follows,

Primary market
The capital market is operated in two main segments such as the primary market and the secondary market. The primary market is used for transactions on new stocks or bond issues, which are handled by issuing houses and underwriters.  

The main entities seeking to raise long-term funds on the primary capital markets are governments (which may be local, state or federal) and business enterprises (companies). Governments tend to issue only bonds, whereas companies often issue either equity or bonds.  

The main entities purchasing the bonds or stock include pension funds, hedge funds, sovereign wealth funds, and less commonly wealthy individuals and investment banks trading on their own behalf.  

Characteristics  of primary market
The characteristics of a primary market include the following.

i ) This is the market for new long term capital. The primary market is the market where the securities are sold for the first time.Therefore it is also called New Issue Market (NIM)

ii) In a primary issue, the securities are issued by the company directly to investors

iii) The company receives the money and issue new security certificates to the investors

iv) Primary issues are used by companies for the purpose of setting up new business or for expanding or modernizing the existing business

v) The primary market performs the crucial function of facilitating capital formation in the economy

vi) The new issue market does not include certain other sources of new long term external finance, such as loans from financial institutions. Borrowers in the new issue market may be raising capital for converting private capital into public capital; this is known as ‘going public’


Methods of getting new issues into the market  
The major issuers of securities particularly the shares are the corporate entities. Government bonds are commonly referred to as "gilt-edged" securities. Intermediaries such as brokers and banks (especially merchant banks) are often used by borrowers to administer the issuing of new bonds. Bonds can be issued in the primary market using several different methods. Both equities and bonds can be issued through the following ways:   

a) Public Subscription  
This presupposes that a prospectus is issued. The document contains details of the company issuing the security such as bond or shares, and of the securities themselves. Members of the public can then subscribe to the security, and the borrower or an intermediary on behalf of the borrower will allocate the securities to subscribers on issue date by means of a certain process.

b) Private Placing
The securities (e.g., shares or bonds can also be issued through private placing. This method is used when the borrower (or an intermediary on behalf of the borrower) places bonds or shares with certain investors selected by the borrower. The selected investor would then receive a certain amount of bonds or shares at issue date and pay the borrower the issue price for the bonds received.

c) Tender Method
A third method used to issue bonds or shares is known as the "tender" method. The borrower or intermediary will issue a media statement that bonds shares will be issued in the market on a certain date.  

The details of the bonds shares and the capitalisation of the issue (total nominal amount to be issued) will also be communicated. Interested parties are then invited to tender before a certain date for these bonds. Tenders from interested parties would normally consist of the nominal amount plus the percentage of the nominal amount that the interested party is willing to pay for the shares or bonds at issue. The company or borrower usually allots the shares or bonds in order of highest tenders first, but it is in his power to decide who will receive the securities at issue date.

d) Tap Method
Another method that is used to issue new instruments is known as the "tap" method, whereby not all the shares or bonds are allocated at the first issue through any of the above three methods. If, for instance, the company or borrower wants to issue N100 million worth of shares or bonds he can choose to issue only N70 million at the first issue. The borrower or intermediary then starts creating a secondary market for these instruments by buying and selling the issued instruments in the secondary market. This process, where one party buys and sells the same instrument in the market, is known as market making.  

The market maker thus has a bid (to buy) and an offer (to sell) in the market for the same instrument, trying to create an active and liquid market in this instrument. The "tap" method is then used by the borrower or intermediary, whereby more instruments are sold in the market than that bought back. By using this method, the amount of the issue is increased, often without the market realising it.  

This method can also be used in inverse form to decrease the total outstanding loan. The ultimate user of the funds from the securities in the capital market can use the tap method, because the company is allowed to trade in its own securities. This is possible in the equities market because a company is allowed to buy its own shares.

Secondary Market

In the secondary markets, existing securities are sold and bought among investors or traders, usually on a stock exchange, characterized by over-the counter, or operated electronically in highly developed economies.  

The existence of secondary markets increases the willingness of investors in primary markets, as they know they are likely to be able to swiftly cash out their investments if the need arises. Transactions in secondary markets: Most capital market transactions are executed electronically, but in less developed stock exchanges sometimes traders are directly involved and sometimes unattended computer systems in highly developed stock exchanges execute the transactions, such as in algorithmic trading system. Most capital market transactions take place on the secondary market. On the primary market, each security can be sold only once, and the process to create batches of new shares or bonds is often lengthy due to regulatory requirements.  

On the secondary markets, there is no limit on the number of times a security can be traded, and the process is usually very quick. With the rise of strategies such as highly frequency trading, a single security could in theory be traded thousands of times within a single hour.  

Transactions on the secondary market don't directly help raise finance, but they do make it easier for companies and governments to raise finance on the primary market, as investors know if they want to get their money back in a hurry, they will usually be easily able to resell their securities.  

Sometimes secondary capital market transactions can have a negative effect on the primary borrowers - for example, if a large proportion of investors try to sell their bonds, this can push up the yields for future issues from the same entity. In modern time, several governments have tried to avoid as much as possible the penchant for borrowing into long dated bonds, so they are less vulnerable to pressure from the markets.  

A variety of different players are active in the secondary markets. Regular individuals account for a small proportion of trading, though their share has slightly increased; in the 20th century it was mostly only a few wealthy individuals who could afford an account with a broker, but accounts are now much cheaper and accessible over the internet.  

These days there are now numerous small traders who can buy and sell on the secondary markets using platforms provided by brokers which are accessible with web  browsers. When such an individual trades on the capital markets, it will often involve a two stage transaction. First they place an order with their broker, then the broker executes the trade. If the trade can be done on an exchange, the process will often be fully automated. If a dealer needs to manually intervene, this will often mean a larger fee.  

Traders in investment banks will often make deals on their bank's behalf, as well as executing trades for their clients. Investment banks will often have a department called capital markets: staff in this department try to keep aware of the various opportunities in both the primary and secondary markets, and will advise major clients accordingly. Pension and Sovereign wealth funds tend to have the largest holdings, though they tend to buy only the highest grade (safest) types of bonds and shares, and often don't trade all that frequently