What are the major functions of capital markets?

Usually, all types of securities are traded in capital markets. Therefore, capital markets perform their duties as a place of security exchange and trade without any limits of investments.

Capital markets usually perform the following two functions −

  • Maintain Liquidity
  • Maintain Fair Price of Securities

Let's discuss these two major functions of capital market in detail −

Maintaining Liquidity

Liquidity is a measure of speed and convenience of transferring assets into cash. Liquidity shows how much and at what speed do the assets are converted to cash. Capital markets perform the duty of converting assets into cash with a certain speed and convenience. Depending on the speed and convenience, the markets are categorized as more or less liquid.

  • Cash is the most liquid asset, as it can be converted to other assets at the best speed and with utmost convenience. Therefore, capital markets allow traders to trade in the market with the most efficiency and speed.

  • Capital markets make securities liquid and transferable continuously and instantaneously. There are many investors who invest their money in capital markets to gain income from the profits incurred due to an increase in the price of the shares.

  • Capital markets reduce the cost of the transaction to the lowest and allow investors to buy securities at the market price without having to pay any fees for making the securities liquid by the markets.

Maintaining Fair Price of Securities

Usually, many people trade securities in the capital markets and this can go up to several thousands of deals every day. The information about these deals is known to all participants of the market. The capital markets are run depending on supply and demand. With an increase in demand, the price of shares goes up. When the supply is more than the demand, the prices go down.

  • As all of the information about capital markets is known to all and no single investor can control the market, capital markets help in the fair pricing of the securities.

  • Financial managers lend and borrow money from capital markets. The markets facilitate the transactions between borrowers and investors. To be efficient in pricing, a fair price mechanism should be in place in such a circumstance. The capital markets thereby make sure that the securities are traded with maximum efficiency at any given moment of the trade.

  • The prices of securities vary randomly in the capital markets and investors and traders have the information of movement of share prices so that they can understand the clues and act depending on the information. The market participants, therefore, adjust the pricing depending on the information received from the market.

The efficiency of Capital Markets is therefore the ability of securities to reflect and incorporate all information regarding the price of securities in the market.