Capital Market

A capital market is the part of the financial system in which governments and companies raise long-term funds, usually for more than a year, by issuing shares and debt securities to investors, and in which those securities are then bought and sold. Its two main branches are the equity market, where ownership stakes are traded, and the debt market, where bonds and similar IOUs change hands.

Capital markets sit alongside the money markets, which handle borrowing for a year or less, and together they make up the wider financial markets. They are supervised by securities regulators, run through stock exchanges and depositories, and measured day to day by indices such as a stock market index.

Think of a town that wants to build a bridge, or a bakery that wants a second shop. Neither has the cash today, but plenty of townspeople have savings they will not need for years. The capital market is the meeting place where the builder asks for that patient money, either by selling a slice of ownership or by promising to repay with interest over a long period.

Once the deal is done, savers are not stuck. If someone needs their money back early, they can sell their slice or their IOU to another person in the same marketplace. That second market is what makes people willing to lend for ten or twenty years in the first place.

The capital market works on two levels. In the primary market, securities are created and sold for the first time. A company floats its shares in an initial public offering, often with an investment bank providing underwriting so that the issuer is sure of the money it raises. A government sells new bonds through auctions, typically to banks and primary dealers.

In the secondary market, existing securities are traded between investors. The issuer receives nothing from these trades, but they matter: they provide liquidity, they set prices through price discovery, and those prices tell issuers what new funding will cost. Secondary trading happens on a financial exchange or over the counter, where dealers quote prices directly to clients, as is common for government and corporate bonds.

The main instruments are listed shares, government bonds, corporate bonds, and Islamic certificates such as sukuk. Pooled products like mutual funds and exchange-traded funds give small savers access, while securitization turns loans into tradable notes. Short-term paper such as Treasury bills and commercial paper normally belongs to the money market instead, and the dividing line is usually the one-year maturity mark.

Participants fall into a few groups:

• Issuers. Companies, banks, state-owned enterprises and governments raise funds by selling securities.
• Investors. Pension funds, insurers, mutual funds, banks and households supply the money and take the risk.
• Intermediaries. Each broker or stockbroker routes orders, while investment banks arrange and underwrite new issues.
• Infrastructure. Exchanges, clearing houses, each central counterparty and securities depositories make up the financial market infrastructure that matches, clears and settles trades.

Capital markets turn household savings into investment in factories, roads, housing and technology, the spending that national accountants record as gross fixed capital formation. Where the stock and bond markets are shallow, firms depend almost entirely on bank loans, which tends to make the banking system the single point through which credit must flow.

Deep markets also spread risk. A bank loan sits on one balance sheet, while a listed bond or share can be held by thousands of investors. The prices those investors set, summarised by measures such as market capitalization, give a running view of what businesses are worth and what the economy expects.

Capital markets are also where most governments finance budget deficits. The long-term part of a government's domestic debt is normally sold as tradable bonds, and the yields on those bonds become the benchmark from which corporate borrowing is priced.

In Pakistan, the equity market centres on the Pakistan Stock Exchange (PSX), formed in January 2016 when the Karachi, Lahore and Islamabad exchanges were integrated under the Stock Exchanges (Corporatisation, Demutualization and Integration) Act, 2012. Its best-known gauges are the KSE-100 Index and the broader All Share Index. The Securities and Exchange Commission of Pakistan regulates the market, while the Central Depository Company and the National Clearing Company of Pakistan handle custody, clearing and settlement.

The government debt market is larger than the equity market. The State Bank of Pakistan auctions Pakistan Investment Bonds (PIBs) and Government of Pakistan Ijara sukuk on behalf of the Ministry of Finance, and these make up most of the country's permanent debt. Commercial banks hold the bulk of these securities, so the line between the capital market and the banking system is thinner in Pakistan than in economies with large pension and insurance sectors.

Capital markets can amplify booms and busts. Prices can run well ahead of fundamentals and then fall sharply, as in the 2008 financial crisis, and a sell-off can cut off funding to firms that did nothing wrong. Small or concentrated markets are prone to manipulation and thin trading, which is why securities law focuses on disclosure, insider-dealing rules and fair access. In countries with capital controls, foreign investors may be restricted, which limits the pool of savings a market can draw on.

• Pakistan Stock Exchange
• State Bank of Pakistan: Central Government Debt