Capital Market Theory

Capital market theory is a generic term for the analysis of securities. In terms of the trade off between the returns sought by the investors and the inherent risks, the capital market theory is a model that seeks to price assets, most commonly, shares. The most talked about model is the Capital Asset Pricing Model. The theory of capital market deals with the following issues:

• Importance of venture capital in the capital market
• Initial Public Offerings
• Role of capital market
• Major capital markets worldwide
• Markets and financial innovations in derivative instruments
• Role of federal reserve system
• Role of securities
• Capital market regulatory requirements

Mortgages, equities, bonds and other investments are traded in the capital market. The financial instruments in this market have long maturity periods. The Capital market theory states that federal funds, federal agency securities, treasury bills, commercial papers, negotiable certificates of deposits, repurchase agreements, Eurocurrency loans and deposits, options and futures are merchandised in the capital market.

When one has to price a security, one has to determine the risk and return of the security both for single assets and for a portfolio of assets. The uncertainty and variability of returns on assets and the possibilities of losses can be defined as risks. The theory of capital market defines returns in the following manner:

K = Pt + Ct - Pt-1 / Pt-1

where the time of purchase of the asset of price Pt-1 is t-1. If this be the case, then, the return (K) from the time period t-1 to t is the above mentioned formula. Ct is the cash got from assets between t-1 and t. Pt is the price of the asset at time t.

For practitioners of the capital market theory, it has not lost its significance. It is still as important for retirement, financial and investment plans

• Role of the government treasury