In addition to the credit market and the money market, the capital market represents one of the three sub-areas of the financial market. In most cases, private investors trade their purchases and sales on the capital market. However, not all capital markets are the same. The main difference is the investor protection in transactions.
- The capital market is one of the three segments of the financial market.
- It offers the possibility of borrowing and raising equity.
- The regulated capital market offers investors the greatest possible security thanks to the disclosure requirement.
- The gray capital market does not provide for investor protection and should only be used with great caution by investors.
The breakdown
Short for CM by abbreviationfinder, the capital market is not a mixture of the most diverse investment opportunities. First of all, a distinction is made between the regulated and the unregulated capital market. Two types of securities are traded on the regulated capital market:
- Shares
- Bonds
The stock market, in turn, is divided into the primary market and the secondary market.
The regulated capital market is opposed to the unregulated capital market. This certainly harbors risks for investors.
Capital market: generation of debt and equity
The capital market is an option for investors for whom the returns on the money market are too low to generate higher returns. The investors on the one hand are opposed to companies or institutions on the other hand that have capital requirements. This capital requirement can consist of temporary borrowings (bonds) or potential equity capital from future co-shareholders (shares).
The capital market is open to all private and institutional investors, public institutions and the state. However, intermediary actors are needed to bring supply and demand together: the banks, brokers and brokers.
When it comes to bonds, returns on the capital market decrease when demand increases. Conversely, falling demand leads to rising interest rates in order to increase the attractiveness of the respective bond.
A balanced capital market and thus an interest rate corresponding to the actual development exists when supply and demand are in equilibrium. An overhang on one side or the other leads to a change in returns.
What other functions does the capital market have?
In addition to traditional trading, the capital market has three other functions:
- Allocation function
- Information function
- Evaluation function
The allocation function defines the relationship between the demand for capital and the supply of capital. For the capital seeker, the allocation is optimal if he receives financing at the best possible price, i.e. has to pay the lowest interest on debt.
Activities on the capital market are only possible if the actors have enough information to make optimal use of their offer or to solve their demand as best as possible. Companies that are active on the regulated capital market are therefore obliged to publish. Investors can use the balance sheets to assess the credit default risk of an inquiring market participant.
The valuation function reflects the price of an investment. That could be the interest rate on a bond or the price of a bond or a share. The pivotal point for the valuation are the stock exchanges. This is where the prices are set that investors are willing to pay. The valuation of a bond’s interest rate is reflected in the price of the security.
This is the difference between interest and dividends. The interest rates also indicate a possible credit default risk. The dividends from stocks are pure company profits that are distributed.
The gray capital market
While the regulated capital market stands for orderly investor protection, this is missing on the gray capital market.
The gray capital market stands for borrowing outside of the stock exchanges. The interest on the bonds that are issued there is well above the interest on the regulated capital market. They reflect the phrase that return prices in investor risk. Medium-sized companies often use this market segment. A fine example of this is a bakery chain that issued a corporate bond in 2010. The issue prospectus was on the counters of the bakery branches as DIN-A4 sheets. The return was well above average. The offer for customers was tempting, but there was no regulation. This meant that there was a risk of a total failure. Investors should always ask themselves when it comes to offers from the gray capital market.