📈 Capital Markets Overview
Definition: Capital markets are financial markets where long-term financial instruments — equities (stocks) and debt (bonds) — are issued and traded. They are the primary mechanism by which companies and governments raise long-term capital.
Key distinction: Money markets (<1 year) vs. Capital markets (>1 year)
🗺️ Structure of Capital Markets
CAPITAL MARKETS
├── EQUITY MARKETS
│ ├── Primary (IPO, follow-ons) → company raises new capital
│ └── Secondary (NYSE, NASDAQ) → investors trade among themselves
│
└── DEBT MARKETS
├── Government bonds (Treasuries, gilts)
├── Investment grade corporate bonds
├── High yield ("junk") bonds
├── Leveraged loans (bank debt)
└── Mortgage-backed / asset-backed securities
🚀 The IPO Process
An Initial Public Offering is a company’s first sale of stock to the public.
Why Companies IPO
- Raise growth capital
- Provide liquidity for early investors/employees
- Currency for acquisitions (public stock)
- Brand awareness and credibility
- Regulatory requirement at certain shareholder counts (>2,000 in US)
IPO Process Timeline (~6–12 months)
| Phase | Duration | Key Activities |
|---|---|---|
| Pre-IPO Preparation | 6–12 months before | Audit financial statements (3 years), clean cap table, hire auditors |
| Select Underwriters | 3–4 months before | ”Bake-off” — banks pitch for lead left role |
| S-1 Registration | 3–4 months before | File with SEC; includes financials, risk factors, business description |
| SEC Review | 1–2 months | SEC comment letters → company responds |
| Roadshow | 2 weeks before | Management presents to institutional investors globally |
| Pricing Night | Night before listing | Book of demand → set final offering price |
| First Day of Trading | IPO day | Stock starts trading; “pop” is first-day return |
| Lock-Up Expiry | 6 months after | Insiders can now sell; often creates supply pressure |
IPO Pricing Mechanics
- Book building: Banks collect “indications of interest” at various price points
- Offering price: Set based on demand; typically 10–15% below clearing price to ensure pop
- Underwriter spread: 5–7% of proceeds (US market) — “the 7% solution”
- Over-allotment (greenshoe): Option to sell 15% more shares if demand is high
Types of IPO Structures
| Structure | Description |
|---|---|
| Traditional IPO | Underwritten by banks; book building; most common |
| Direct Listing | Company lists without underwriters; no new shares (Spotify, Palantir, Coinbase) |
| SPAC | Special Purpose Acquisition Company; reverse merger |
💵 Bond Markets
Bond Fundamentals
A bond is a debt instrument with:
- Principal (face value): Amount borrowed, repaid at maturity
- Coupon: Periodic interest payments (annual % of face value)
- Maturity: When principal is repaid
Where C = coupon, r = yield, FV = face value
Key relationship: Price ↑ → Yield ↓ (inverse relationship — critical to internalize)
Bond Categories
| Category | Credit Rating | Yield | Risk |
|---|---|---|---|
| US Treasuries | AAA (risk-free) | Lowest | Minimal |
| Investment Grade Corps | BBB and above | Low-moderate | Low |
| High Yield (“Junk”) | BB and below | High | High; default risk |
| Leveraged Loans | Non-rated, secured | High, floating | High; PE LBOs |
Credit Ratings
| Agency | Investment Grade | High Yield |
|---|---|---|
| Moody’s | Aaa through Baa3 | Ba1 through C |
| S&P / Fitch | AAA through BBB- | BB+ through D |
The Yield Curve
Plot of yields across maturities (3-month → 30-year Treasuries):
- Normal: Long yields > short yields (growth/inflation expected)
- Inverted: Short > long → recession predictor (every US recession preceded by inversion)
- Flat: Transitional
🔄 Market Participants
| Participant | Role |
|---|---|
| Investment banks | Underwrite new issuances; market makers |
| Institutional investors | Asset managers, pension funds, insurance cos. — primary buyers |
| Hedge funds | Arbitrage, event-driven, long/short strategies |
| Retail investors | Individual investors; smaller role in primary markets |
| Central banks | Buy bonds for monetary policy (QE) |
| Sovereign wealth funds | Large national investment funds (Norway, Saudi Arabia) |
🔗 Connected Concepts
- Investment Banking Overview — Banks underwrite capital markets transactions
- Capital Structure — Capital markets are where companies raise debt and equity
- WACC — Equity and debt costs determined by capital markets
- Monetary Policy — Central bank actions directly move bond markets
- LBO Model — High yield bonds and leveraged loans fund LBOs
← 📊 Finance MOC | Related: Investment Banking Overview · Capital Structure · WACC