(a) Explain the term capital market. (b) How is the capital market different from the stock exchange? (c) What are the advantages of the capital market?

Answer Details

(a) Capital market. The capital market is the market for the buying and selling of long-term securities, that is, financial instruments with a maturity of more than one year, such as shares, debentures, bonds and government stocks. It provides long-term funds to firms and governments and is made up of a primary market (where new securities are first issued) and a secondary market (where existing securities are resold), together with institutions such as the stock exchange, development banks, insurance companies and issuing houses.

(b) How the capital market differs from the stock exchange. The stock exchange is only part of the capital market. The stock exchange is the organised secondary market where existing (already issued) securities are bought and sold. The capital market is wider: it includes the stock exchange plus the primary market for new issues and the other institutions that supply long-term funds. In short, every stock exchange is part of the capital market, but the capital market is much more than the stock exchange.

(c) Advantages of the capital market:

• It mobilises long-term savings and channels them into productive investment.
• It provides long-term capital for firms and governments to finance expansion and development projects.
• The secondary market gives securities liquidity, so investors can sell when they need cash, which encourages people to invest.
• It encourages the saving and investment habit and widens share ownership.
• It provides a channel for privatisation and for attracting foreign investment.

Examination takeaway: the key distinction in (b) is scope, the stock exchange handles existing long-term securities, while the capital market covers new issues as well and the whole set of long-term-fund institutions.