Assuming you have superficial knowledge about the subject, we’ll take an example of local marketing to understand the meaning of financial markets. Let’s begin!
The next door Market
What do you do when you visit the local market for buying vegetables? Bargain on the price if you find the price too high, right? And then you and the vendor agree on one price and the trade takes place. A financial market is no different than your local sabzi mandi, except that financial products such as equity shares and bonds, currencies, and commodities are traded in these markets. These markets too work on the play of supply-demand (bargaining). There are different types of markets but we will take a look at capital markets in this article. Before we learn about capital markets, we’ll have to understand certain terminologies.
Equity shares are financial products that give their owner ownership of the company proportionate to the volume of shares owned. Let’s say there is company-A, which is a privately help company. As it grows, it will require more and more capital and to raise this capital one of the avenues it takes is issuance of equity shares. These shares are issued on the stock exchange, where investors buy them. The process of issuing shares for the first time is called the Initial Public Offering (IPO). In return of purchase of shares, investors get the ownership of the company. Not only this, they also expect dividend on the shares. Equity shares also give shareholders (investors) the right to vote in the company’s key decision making processes. The company, however, is not obliged to pay either dividends or the equity capital raised to the investors.
But equity shares are not the only means for raising money. Companies or governments often issue bonds or debentures to raise capital. Bonds are basically loans but they differ in that the lenders are not necessarily banks. They give the investors (lenders) a fixed return just as banks get fixed interest on the loans they issue. This interest return is termed as “Coupon”. No voting rights are given to bondholders (investors) and the company is obliged to repay both principle and interest within the predefined tenure of the bond.
Now, we know enough to understand capital markets. Let’s move ahead.
Capital Markets help businesses raise money that they require to run their operations or expand them, just as banks will help your local sabziwala by lending him money. It is essentially a place where entities with surplus capital meet companies or governments in need of capital. Equity shares and bonds are traded in these markets. Equity shares are traded in the stock market and bonds are traded in the bond markets.
Capital markets further consist of primary and secondary markets.
Primary market is the place where shares or bonds are issued by businesses for the first time. These shares or bonds are bought by investors and the money is paid to the businesses. In return, they expect returns on the investment made in the form of dividends on shares and interest on bonds.
In the secondary markets, businesses disappear out of the picture, and traders come in. It is a place where buyers and sellers trade the shares and bonds after they are issued in the primary market, amongst themselves. In these markets, the money flows from buyers to sellers and none of it goes to the businesses.
These transactions take place over exchanges. I’m sure you have heard of the stock exchanges of Mumbai such as the Bombay Stock Exchange (BSE) and National Stock Exchange (NSE). These exchanges act as intermediaries in the transactions and are the heartbeat of any economy.
Author: Shivam Ghule, is a co-author at CaseReads; We hope we were able to help you drive home the meaning of financial markets.