Companies use capital markets, such as stock exchanges, to raise capital.
A capital market can be defined narrowly as the market for investors to trade in securities, and more broadly as the market for companies and governments to raise money or capital. An efficient capital market is one in which prices change rapidly in response to changes in supply and demand, thus producing “fair” prices at a given time. In addition to information, an efficient capital market will generally require liquidity through a large enough collection of traders to accurately influence prices.
The capital market consists of securities, both debt products such as bonds and equity products such as stocks. It is usually defined as securities in which the issuer will have more than a year to repay the initial payment. This means that short-term securities, such as Treasury bills, are traded on a different type of market, often called the money market.
There are two main forms of capital markets. The primary market is where companies and governments create and sell bonds, usually through an underwriter. The secondary market is where traders buy and sell these bonds to each other, which means that the investor who ends up redeeming a bond or receiving dividends on the stock is often not the investor who originally paid the money to the issuer.
An efficient capital market is generally defined by the availability and accuracy of information about securities and their prices. Economic theories of the market are generally based on the idea that every trader has complete information about the securities available and the price demanded, together with any other details that may be relevant, such as past market behavior, the performance of the company that issues the shares. ., or the probability that an issuer of debt securities will repay the money as promised. The more efficient a capital market is, the closer the actual situation will be to this hypothetical situation. The idea is that the more efficient the market, the more informed investors’ judgments and decisions will be, and therefore money will be allocated in the most productive way overall.
One rating provides three levels of efficiency. A weak and efficient capital market is one in which only information about the past is reflected in bond prices. A semi-strong efficient market is one in which current publicly available information is known to all investors and is reflected in prices. A strong and efficient market is one in which investors know all the information, even that which is not publicly available; this is indeed the situation assumed by market theories, but unlikely in the real world.