FINANCIAL MARKETS:
Loan-able funds move from the savers to borrowers.
Financial system carries out all of its operations through the financial market where loan-able funds are converted from savings to investment.
Financial claims & services are traded through the financial market.
We can divide financial markets into two broad categories:
Money market
Capital market
Money market makes short term loans measuring less than 1 year. It meets the needs of borrowers who have temporary shortage of funds.
The function of money markets:
Money market finances the working capital needs of the businesses. Money market provides the govt. with short-term funds as a substitute of tax collections. It supplies funds to consumers for the purchases of commodities and speculative buying of securities.
Capital markets deal with financial instruments measuring more than 1 year. In the capital market, funds flow from the suppliers to the demanders for long-term investment such as to purchase home, automobiles, for the construction of factories, buildings, to create public facilities.
Money market can be subdivided according to the financial securities traded in the market:
Treasury bills: Issued by the govt.
Certificates of deposits: Issued by banks and other depository institutions
Bankers' acceptance: Issued by banks to make facilities for overseas business
Commercial paper: Issued by large and well-reputed corporations
Federal funds: The reserve balances of banks in the central bank
Euro currencies: It is a deposit of world's major currencies with the central bank
TYPES OF CAPITAL MARKETS:
1. Mortgage loans: to support the building of homes, factories, shopping malls, etc.
2. Long-term govt. bonds: more than year
3. Many consumer loans more than 1 year
4. Corporate stock
5. Corporate notes and bonds (more than 1 year)
Financial markets can be further subdivided according to the nature of trading of the financial securities. Examples:
1. Open markets: It is the institutional mechanism in which any individual or institute can participate to trade securities. Usually, financial instruments are sold to the highest bidder.
2. Negotiated markets: It is the institutional mechanism in which terms of trading are set by direct bargaining between buyers and sellers (both price and quantity are bargained)
Instruments are sold to one or few buyers under private contract. Example: Bargaining between lender & borrower on loan amount & interest rate.
3. Primary markets: The market in which financial instruments are issued for the first time. Example: Financial capital is raised by issuing new stock of shares by a company for the first time.
4. Secondary markets: This is the market in which previously issued securities are traded among investors. Activities in the secondary market of a specific instrument have strong influences for issues in the primary market.
Liquidity
Tradability
Demand of the security
Market rates
5. Spot markets: Financial securities are traded for immediate delivery. The closing of transactions and delivery of securities take place on the spot within a very short period of time (within 2 business days)
6. Forward markets: It is a market for delivery of securities at some later date. The contracts are made for the future delivery of financial instruments. The forward market is the market where the delivery date & the price are determined now. The delivery of securities takes place in the future.
7. Option markets: It makes possible the trading of option on selected bonds or stocks. For example, preferred stocks convertible to common stocks.
Contracts in the option markets give the investor the right to buy or sell certain securities at a specified price at any time during the life of the contract.
