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Knowledge of Capital Markets

The capital markets connect businesses and governments that need money with investors who want to put savings to work. This chapter covers how securities are issued and traded, who oversees the system, and how the broader economy shapes prices.

Primary vs. Secondary Markets

The primary market is where an issuer sells brand-new securities and receives the proceeds directly, such as during an initial public offering (IPO). The secondary market is where investors trade those already-issued securities among themselves, on exchanges or over the counter, with no new money going to the issuer.

Primary market
Issuer raises capital by selling newly created securities; the sale proceeds go to the company or government issuing them.
Secondary market
Existing securities change hands between investors; the issuer is not a party and receives none of the money.
IPO
An initial public offering is a private company's first sale of stock to the public, moving it into the primary market.

Underwriting and the Prospectus

When a company goes public it hires investment banks, called underwriters, to help price the deal and distribute shares. The issuer files a registration statement with the SEC, and investors receive a prospectus that discloses the material facts and risks of the offering.

Underwriter
An investment bank that agrees to buy or market an issuer's securities and resell them to the public, often forming a syndicate to spread risk.
Securities Act of 1933
Registration and prospectus
New public offerings must be registered with the SEC, and buyers must receive a prospectus disclosing key financial and risk information.
Securities Act of 1933
Cooling-off period
After filing, a mandatory waiting period runs before the sale can be finalized; only a preliminary prospectus (red herring) may circulate.

Exempt Offerings: Reg D and Reg A

Not every sale of securities must be fully registered. Regulation D allows private placements to sophisticated and accredited investors, while Regulation A permits smaller public offerings with lighter disclosure requirements.

Regulation D
Permits private placements sold mainly to accredited investors without full SEC registration, in exchange for limits on advertising and resale.
Securities Act of 1933
Regulation A
Allows smaller offerings to the public under a simplified disclosure document, sometimes called a mini-registration.
Securities Act of 1933
Accredited investor
An individual or entity meeting income or net-worth thresholds, presumed able to bear the risk of unregistered offerings.

The Regulators

A layered system of federal agencies and self-regulatory organizations governs U.S. securities activity. Each body has a defined slice of authority, from setting rules to insuring accounts.

SEC
The federal agency that enforces securities laws, reviews registrations, and oversees markets and firms.
Securities Exchange Act of 1934
FINRA
A self-regulatory organization that writes conduct rules for broker-dealers, licenses representatives, and enforces industry standards.
MSRB
Sets rules for firms dealing in municipal securities, though it relies on the SEC and FINRA for enforcement.
FDIC vs. SIPC
The FDIC insures bank deposits, while SIPC protects customer assets held at a failed brokerage up to set limits; neither covers investment losses from market moves.

The Federal Reserve and Monetary Policy

The Federal Reserve is the nation's central bank and manages the money supply to promote stable prices and employment. It influences interest rates through tools that expand or contract the amount of money circulating in the banking system.

Open market operations
The Fed buys government securities to add money to the system and lower rates, or sells them to drain money and raise rates.
Discount rate and reserves
The Fed sets the rate it charges banks for short-term loans and the reserves banks must hold, steering how freely credit flows.
Easy vs. tight money
Loosening policy lowers rates to spur borrowing and growth; tightening raises rates to cool the economy and fight inflation.

Economic Factors and the Business Cycle

Securities prices respond to the health of the overall economy, which moves through repeating phases of growth and contraction. Investors watch inflation, interest rates, and government policy to gauge where the cycle is headed.

Business cycle
The economy cycles through expansion, peak, contraction (recession), and trough; two consecutive quarters of falling output signal recession.
Inflation and CPI
Inflation is a general rise in prices that erodes purchasing power, commonly measured by the Consumer Price Index.
Fiscal vs. monetary policy
Fiscal policy is Congress and the President using taxing and spending, while monetary policy is the Fed managing money and interest rates.
Yield curve
A normal curve slopes upward as longer maturities pay more; an inverted curve, where short rates exceed long rates, often warns of recession.
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Understanding Products and Their Risks

Last updated: July 2026

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