Understanding Capital Markets
This video in the Tools for Enhancing the Stock Market Game™: Invest it Forward™ series defines stocks and bonds and provides an explanation of what capital markets are and how they work.
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The Tools for Enhancing The Stock Market Game™: Invest it Forward™ video series is brought to you by the Federal Reserve Bank of St. Louis in cooperation with the SIFMA Foundation. These videos are designed to help students better understand stocks, bonds, primary and secondary capital markets, saving and investing, the role and benefits of the capital markets and more.
For a more detailed overview than the video includes, check out our online course, Capital Markets. Content includes an understanding of capital markets, financial assets such as stocks and bonds, primary and secondary markets, financial capital and risk. After completing this course, viewers will understand the role of capital markets in the economy and will be able to explain why savers, businesses, governments and entrepreneurs participate in capital markets.
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What image comes to mind when you hear the word “market”? Do you picture a grocery store or a produce market in a town square, or perhaps a shopping mall?
These are all examples of markets, but you might be surprised to learn that some important markets aren’t stores at all. In fact, the buyers and sellers will probably never meet. But our economy would not function the same without these markets—they are capital markets.
Capital markets are financial markets that bring buyers and sellers together to trade stocks, bonds, currencies, and other financial assets. Capital markets include the stock market and the bond market. They help people with ideas become entrepreneurs and help small businesses grow into big companies. They also give folks like you and me opportunities to save and invest for our futures.
Here’s an example. Meet John. John has an idea for a new business—delicious ice cream that's healthy enough to eat anytime of the day. Yum! He saved his money in the bank, earned interest, and used that to start his business. John tests the market, and BOOM, his product is a hit. In fact, there's so much demand he can't fill ice cream cones fast enough; the business is growing! John needs to hire people to help him produce, sell, and deliver his ice cream. He needs more ingredients from his suppliers, like the fruit seller and the cone baker. John doesn't have the money to pay for all of this right now, but according to his business plan and test market results, he’s going to make millions in the first year. Enter: capital markets.
Financial capital is money entrepreneurs and businesses use to buy resources and supplies. These are then used to make products or provide services to buyers. Financial capital is raised through capital markets in two ways—by selling bonds, which are like loans that the business will repay at a later date with interest, or by selling stocks, which are sold in exchange for the partial ownership of the business.
Issuing or selling stocks takes place through an IPO or initial public offering. The amount buyers are willing to spend and sellers want to make determines the price of the stock. Unlike a loan, which has to be repaid, issuing an IPO or "going public" allows others to buy a share or a portion of your business and become a partial owner. The person or institution with the most shares at any time is the company's main owner.
Many small businesses conduct IPOs and earn money to become large companies. These companies expand across the country and create thousands of jobs. They also stimulate new businesses related to supplies, production and delivery, and provide a good or service that consumers value.
People buy stock because they believe eventually the value of the stock will go up, allowing them to sell the stock at a higher price than the initial purchase price. The risk is that the value of the stock could go down.
A company may issue bonds instead of stocks. A bond is a loan investors make to a company or government. Unlike stockholders, bond purchasers are not company owners. Instead, they receive interest payments and are repaid the loan amount at a future date. Businesses issue bonds and so do federal, state, and local governments. Bonds often help pay for big projects, such as new schools, hospitals, stadiums, and road repairs.
Without markets for stocks and bonds, business owners would have fewer options to bring their ideas to life or to expand their businesses; they would have to save up enough cash to re-invest. With healthy capital markets, business owners can obtain the needed financial capital to build successful companies. They can also expand existing businesses to create new jobs and strengthen the economy.
Capital markets also reduce the cost of doing business by providing the global economy with a reliable source of cash or liquidity.
Capital markets bring borrowers and lenders together in efficient ways and help channel resources to create a healthy national and global economy. They provide essential funding that affects people's lives in many ways, from starting a business to expanding a current one, or providing investment opportunities for people planning for their future. Capital markets allow traders to buy and sell stocks and bonds, and enable businesses to raise financial capital to grow. Businesses also have reduced risk and expenses in acquiring financial capital because they have reliable markets where they can obtain funding. Capital markets are there to match them with the best funding source. One day, you might have an idea—like healthy ice cream—that you want to turn into a business. Capital markets will be there to help make it happen. And that’s the scoop!
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