Capital markets are the lifeline of the economy because it is through capital market new as well as existing companies can raise funds from the market. Capital market in simple words refers to that market in which individuals and companies buy and sell various financial instruments like equity shares, debentures, futures and options of various instruments, preference shares, bonds, and so on. In order to get a better idea about the capital market, one should look at some of the advantages and disadvantages of the capital market –
Advantages of Capital Market
Facilitates Transactions
The first and foremost advantage of capital market is that it facilitates transactions between the people who are savers that is individuals, banks, high net worth individuals, and spenders that are the companies who are in constant need of funds and thus helps the savers in earning income in the form of dividends, interest, and capital appreciation while companies can also use this money to grow and become big. In simple words, the capital market acts as a great mediator between two sides while one side has plenty of money but no opportunities and the other side has plenty of opportunities but no money and thus capital market bridges that gap and helps both sides.
Liquidity
Capital markets are very liquid in the sense that investors can invest and take their money out from the market whenever they require the money which is not the case with other markets like the real estate market where one cannot easily enter or exit from the market. In simple words, the fact that you can buy and sell securities in the capital market with a click of a button ensures that you will never have to suffer due to lack of liquidity and hence this factor ensures that investors and companies have more confidence in the capital market as compared to other markets.
Helps in Diversification
The capital market is not limited to only equities rather there are many other instruments like derivatives, swaps, mutual funds, debt instruments and so on which in turn helps the investors in diversifying their portfolios and earn a superior return. In simple words, the capital market is not a single flower-like fixed deposit of a bank rather it is a bouquet of flowers that caters to the needs of different types of investors by offering different instruments in one place.
Disadvantages of Capital Market
Risky
The biggest drawback of the capital market is that it is very risky because all instruments of capital markets whether its equity shares, derivatives, swaps have an inherent risk associated with them, and hence many innocent investors lose their life savings due to wrong decisions and bad investment in capital markets. In simple words, investors who want safety and are accustomed to steady returns should avoid the capital market as it is not a place for weak-hearted people.
Additional Costs
In the case of capital markets, there are many costs like brokerage, exchange fees, taxes and so on which makes trading in capital markets expensive as compared to bank fixed deposits where there are no such costs and hence puts an additional burden on people investing in capital markets.
Complex
Various instruments of capital market are not easy rather have many complexities which makes them even more difficult to trade and make money from that trading. Hence various instruments like futures, options, swaps, and various strategies like straddles, strangles, covered call, bond swapping, and so on are not easy to understand and people having financial background can understand them and trade them successfully.
As one can see from the above that capital market has pros as well as cons but the fact is that capital markets are necessary and no country can afford to operate without a capital market and that is the reason why one should try to avoid and take precautions with regards to various cons of capital market as the capital market cannot be closed just because of cons as its pros outweigh its cons by a huge margin.