What makes the capital market tick? We will try to explain the capital market in simple language and have a look behind some words you may or may not know.
The result goes up, the share price goes down – and vice versa. This raises the question: How do analysts actually assess a company and what do investors act on? We answer questions about the capital market.
What is meant by the capital market?
The term “capital market” refers to all institutions and also processes that bring together capital providers and capital seekers. Capital seekers are companies, households and also states that obtain money on the capital market that they need for investments, for example. On the other hand, there are the capital providers who make the required money available in the short to long term. The “law” of supply and demand governs.
If securities are traded via banks, stock exchanges or insurance companies, the term organized capital market is used. This is subject to legal regulations and government supervision and is in turn divided into the bond market, which is available for long-term capital procurement via loans, and the stock market, on which company shares (stocks) are traded.
-> All financial market terms are described in the glossary below.
Which players are there on the stock market and how do they differ?
There are three main groups in the stock market.
Firstly, there are the companies whose securities are traded.
Then there are the analysts of the banks and brokerage houses, who are called “sell-side”. Based on their analyses, they make recommendations to buy, hold or sell stocks.
Its customers are institutional and private investors (“buy-side”). Depending on the investment strategy, they are divided into short-term or long-term investors and active or passive investors. In their portfolios (funds), passive investors track an index such as the S&P 500 or the Euro Stoxx 50. Active investors, on the other hand, invest in individual stocks, i.e. they engage in so-called “stock picking”.
What is traded where on the capital market?
On the stock market – as the name suggests – shares are traded. But also bonds, which companies place on the market to obtain money at a usually fixed interest rate. Commodities such as precious metals, oil or agricultural products are traded on commodity futures exchanges. Currencies are mainly traded via foreign exchange dealers at credit institutions and central banks. At around 3 trillion US dollars a day, worldwide foreign exchange trading is many times greater than trading in shares. The bond market offers fixed-interest securities such as government bonds, municipal bonds, mortgage bonds or bonds issued by public-sector credit institutions (e.g. pension funds).
Why does the share price of a company often develop contrary to its results?
If a company announces good operating results, the share price often goes down – and vice versa. Often such a price movement is explained by the old stock market saying: “Sell when the news is good and buy when it is bad”. This means that investors sell their shares and take profits when expectations are met and good news is confirmed. Conversely, investors buy when share prices are low and speculate on rising prices. As a result, the price of Pfizer stock may fall temporarily, even though earnings have increased compared to the previous quarter.
Which factors play a role in purchasing decisions? What makes the capital market tick?
The stock market does not evaluate past results, but rather expected future profits. In addition to corporate strategy, the general economic situation and the general political climate also play a role. It is fantasy and trust that make investors invest. This becomes particularly clear with Tesla or Uber. Both companies achieve a very high valuation on the stock market, although they have made practically no profit for years. But despite all the speculation about large profits, even the best vision should at some point become reality and yield profits, otherwise shareholders will be disappointed and sell again.
How important are the current share price and a dividend to investors?
Many investors – depending on their willingness to take risks – aim for a high total return on their investment in a share, called “total shareholder return”. This is derived from the share price performance and the dividends received.
The share price development is a major lever and a significant factor in the purchase decision. Investors rely on the fact that shares they buy at a currently low price will develop positively as quickly as possible and can then be sold at a profit.
The annually distributed dividend is also a great incentive for investors. Particularly in times of little movement on the stock markets, shareholders can “earn” a good deal through the dividend alone. Even though the amount of the dividend is usually based on the company’s profit, which can fluctuate, reliably paid dividends offer investors a certain degree of security.
What role does the rating play?
The rating plays only a subordinate role for equity investments; it is primarily relevant for taking out loans. A credit rating measures and evaluates the creditworthiness of companies, that is, whether the company is able to repay its loans and interest on the due date. The better the rating, the lower the risk surcharges and thus the costs of obtaining outside capital (for example, when issuing bonds). A good rating also facilitates access to the capital market. This means that the company has a greater choice of lenders and financing instruments at its disposal.
Can companies be compared based on their share price alone?
It is worth taking a look at the price development over a longer period of time. On the basis of this development, it is possible to see which shares are in demand and which are not in demand or are even sold. It is certainly possible to draw conclusions about the performance and attractiveness of companies.
Glossary of terms relating to the capital market
When talking about the capital market, a lot of financial vocabulary is used. But what exactly are stocks, bonds and analysts? We have briefly explained some selected terms for you here.
Share
In short, shares are share certificates in a company. Anyone who owns one or more shares is thus a co-owner of a company. These shares can be bought and sold again. The value of the share changes continuously through its trading and is expressed in the share price. Daimler has approximately 1 billion shares in circulation.
Stock market index
A stock index expresses in a key figure the performance of selected stock prices at a certain point in time. Indices often represent the largest companies in an economy or business sector. They are therefore useful barometers of public opinion.
Examples:
-DAX (German stock index): The DAX is made up of the 30 companies with the highest free float market capitalization and the highest share turnover in the German stock market.
-TecDAX: The TecDAX is a German stock index consisting of the 30 technology companies with the highest free float market capitalization and the highest share turnover in their respective sectors.
-Dow Jones: The American equivalent of the DAX. Full name: Dow Jones Industrial Average. Here too, the selection criteria for the 30 largest US companies are their free float market capitalization and share turnover.
-Nikkei 225: The leading Japanese index and the most important stock index in Asia. It includes the 225 Japanese companies traded on the Tokyo Stock Exchange.
Share price
The share price describes the value of a share at a certain point in time. Because demand and supply are constantly changing, the share price also fluctuates.
Stock market
On the stock market – part of the capital market – only shares are traded. This trading is determined by supply and demand. The core of the stock markets are the stock exchanges, such as the famous New York Stock Exchange. The stock market is a public market where companies issue shares and investors can trade shares.
Shareholders
Anyone who owns shares in a company and is therefore a co-owner of a company can call himself a shareholder. In return for their investment in the company’s shares, shareholders expect a dividend and price gains.
Analysts
Analysts monitor and evaluate the strategic and economic development of companies as well as markets and raw materials. Their trading recommendations (buy-hold-sell) can have a major influence on the price of a share. Analysts who specialize in the stock market often work for banks or independent financial institutions.
Bonds
Bonds are usually fixed-interest securities with which companies can obtain money on the capital market without having to sell or issue their own shares. The borrowed money is returned to the investors with interest. Bonds are also known as annuities.
Stock exchange
The stock exchange was established as a place where securities were traded a little more than 400 years ago. Supply and demand determine trading. Today, these marketplaces can also be virtual. Well-known stock exchanges include the New York Stock Exchange on Wall Street, the London Stock Exchange in the City of London and the Frankfurt Stock Exchange. In addition to shares and bonds, commodities and currencies are also traded on these exchanges.
Brokers
Brokers – stockbrokers in English – are financial service providers who have specialised exclusively in securities trading. In most cases they are active on the stock exchange to buy or sell shares for their customers. For their services, brokers receive a commission from their customers, which is dependent on the trading profit.
Bull & Bear
The image of the bull and the bear symbolizes the two conflicting groups in the securities market: The bull embodies the optimistic traders who are betting on rising prices, while the bear stands for those buyers who are more likely to be led by the expectation of falling prices.
Dividend
The dividend is the participation of the shareholders in the profits of the company. In Germany it is paid out once a year from the previous year’s profit. The company’s Annual General Meeting determines the amount of the dividend per share.
Dividend yield
The dividend yield is a key figure for evaluating and comparing shares in percent. It expresses the ratio of the dividend paid by the company to the share price: To calculate the dividend yield, the dividend per share is simply multiplied by 100 and then divided by the share price.
Financial Market
The financial market is the generic term for all markets on which financial trading is carried out. It is subdivided into the money market, credit market and capital market.
Money Market
The money market is a sub-market of the financial market that serves, among other things, to raise capital at short notice to bridge liquidity problems. Central bank deposits with short maturities between one day and one year as well as money market paper are usually traded on the money market. The commercial banks, the European Central Bank (ECB) and, in Germany, the Deutsche Bundesbank participate in the money market.
Investors
Investors are institutional investors, such as investment companies, large private shareholders and sovereign wealth funds, which invest, for example, in shares or bonds in order to make a profit. Investment companies, for example, manage investors’ money with the aim of increasing it. They often act on behalf of companies such as pension funds or life insurance companies.
Capital Market
In addition to the money market, the capital market is a part of the general financial market. The term covers all processes and institutions that bring together capital providers and capital seekers. On the capital market, companies, households and governments can obtain capital that they need for investments, for example. Accordingly, the capital providers make the money available in the medium or long term. Supply and demand determine trade.
Credit Market
The credit market is the part of the financial market where credit transactions are concluded. The focus here is on longer-term transactions. One part of the credit market is the bond market, the other main component is bank loans.
Market capitalization
The market capitalization indicates the calculated total value of a company’s shares on the stock exchange. It is the product of the current share price and the total number of shares of a company in circulation.
Pension market
The bond market is part of the organised capital market. It is therefore subject to legal regulations and state supervision. Bonds have nothing to do with pensions as we know them from the state. Rather, fixed-interest securities are traded on the bond market – these are bonds and debt securities, known as bonds. Companies issue bonds in order to obtain medium to long-term money for refinancing. The lenders receive previously agreed interest in addition to the repayment. Bonds are thus used by the debtor for debt financing and by the creditor for capital investment.
We hope we have been able to make the language of the capital market a little easier for you to understand and wish you many good investments for the future.
If you want to know more about the stock market and the capital language, have a look at 37 Stock Trading Terms Every Trader Needs to Know.
Other interesting articles about wealth can be found HERE
If you want to learn more about the banking system, have a look at The Evolution of Banking Over Time