BASICS OF FINANCIAL MARKETS
A financial market is a marketplace where buyers and sellers participate in the trade of assets such as equities, bonds, currencies and derivatives. Financial markets are typically defined by having transparent pricing, basic regulations, costs and fees, and market forces determining the prices of securities that trade. Markets are not the same; they vary in size of trading volume, participants and value of operations.
In finance, the importance of markets originate from the concept of available liquidity, or in other terms, higher trading volumes and a proportionally high number of participants which renders each purchase or sale possible. Financial markets are formed in nearly every country in the world. Some are very small, with only few participants, while others – like the New York Stock Exchange (NYSE) and the foreign currency exchange markets – trade trillions of dollars on a daily basis.
The financial markets are driven by economic systems where countries and governments distribute resources and trade goods and services.
The private sector involved in financial markets could be characterized by two main segments:
The household segment includes the consumption-seeking members of society. In effect, the economy exists to satisfy the wants and needs of the household sector.
2- BUSINESS (or CORPORATE SECTOR)
It is the economy made up by companies which in principal sell their service to households. Companies, across all business sectors, need financing to operate and expand. Funds are required to purchase assets for business; for example buy new machinery, land, warehouses, expertise, trademarks.
Companies also require funds for handling operations, such as paying salaries, buying from suppliers, or marketing their products among other things.
But how do these two segments of an economy meet and transact which each other? The do so in the following manner:
a- Banks: Households deposit their money in banks (through current or savings accounts) and the bank lends to companies for business purposes.
b- Financial Markets: Households buy shares in companies thus turning them into shareholders (owners), or households can buy debentures issued by companies, thus in principal lending their savings to companies through financial markets.
MAIN FUNCTIONS OF FINANCIAL MARKETS
1- FACILITATE THE TRANSFER OF MONEY FROM SAVERS TO INVESTORS (HOUSEHOLDS TO COMPANIES)
2-PROVIDE LIQUIDITY TO FINANCIAL ASSETS
When investing in any asset, investors needs to keep their liquidity levels in mind because it can be difficult or time consuming to convert certain assets back into cash. For that reason, Financial markets stimulate liquidity in the ease with which an individual or company can meet their financial obligations with the liquid assets available to them.
3-SAVE TIME, MONEY AND EFFORTS FOR BUYERS AS WELL AS SELLERS
A financial market is a market that brings buyers and sellers together to trade in financial assets such as stocks, bonds, commodities, derivatives and currencies. The purpose of a financial market is to set prices for global trade, raise capital and transfer liquidity and risk.
4-PROVIDE PRIMARY INFORMATION IN THE MARKET
Financial markets reveal information about important economic and financial variables such as commodity prices, interest rates and company values (stock prices).
Financial markets provide extensive data that can be useful to financial managers. Examples include:
-Prices for agricultural commodities, metals, and fuels.
-Interest rates for a wide array of loans and securities, including money market instruments, corporate and government bonds, and interest rates for loans and investments in foreign countries.
-Foreign exchange rates.
-Stock prices and overall market values for publicly listed corporations, as determined by trading on the New York Stock Exchange, NASDAQ, or stock markets in London, Frankfurt, Tokyo, Beirut Stock Exchange and other international exchanges.
TYPES OF FINANCIAL MARKETS
There are two major segments in financial markets:
1-MONEY MARKET: SHORT-TERM PERSPECTIVE
Money Markets are characterized by two main features they are highly liquid and considered to have a short maturity, usually ranging between 30 days to one year. For that reason, money markets are commonly known as being one of the safer investments.
Nevertheless, investors should always be aware of the availability of risks; mainly risk of default. Some examples of traded securities in the money market include Treasury bills, Certificates of Deposit (CDs), commercial paper and in many countries, municipal notes. Even though money markets do not yield a high return, they offer higher interest rates than most savings accounts and are more convenient for short–term investors.
Example: Purchasing a Certificate of deposit, Eurodollar, or a treasury bill with a maturity between one day up to one year, and a yield (return) of 6% on the principal value of the security.
2-CAPITAL MARKETS: LONG-TERM PERSPECTIVE
Capital Markets are perhaps among the most utilized markets globally. They are mainly used by companies and governments for long term borrowing, or financing, through both the bond market and the stock market.
Capital markets channel savings and investments between retail investors and institutional investors to Capital employers such as businesses, governments and individuals. Capital markets include primary markets, where new stock and bond issues are sold to investors, and secondary markets, which trade existing securities. For that reason, capital markets are vital to the functioning of modern economy driven by the effects of demand and supply. Strong capital markets are a sign of a growing and vibrant economy capable of producing jobs and enhancing wealth creation.
Example: Suppose HOLCIM decided to raise more funds by issuing ten new shares of stock for $100 per share. HOLCIM offers these shares in the market and someone purchases all ten for $1,000 total. The investor now has partial ownership of the company. HOLCIM gets the $1,000 in funds they wanted to raise. Should this investor wish to no longer hold these stocks, he can sell them to another investor in the stock market for the market price quoted at sale.
Securities are fungible and negotiable financial instruments that represent some type of financial value. The company or entity that issues the security is known as the issuer.
AN OVERVIEW ON THE PRIMARY AND SECONDARY MARKETS
Here we can see that there are two types of markets related to the Capital Markets where shares and bonds are traded:
Markets are divided into two types by the nature of the securities traded. If the security is offered on the market for the first time, the market for such a security would be called a Primary Market. Hence, it is the market where new shares, stocks, or bonds are issued for the first time on an exchange. In this market, investors purchase securities from the issuer directly.
The process of issuing securities on a market is not straightforward. Specific types of institutions are involved in the preparation of securities to be listed on Primary markets. Investment banks which complete the underwriting of securities for companies that are considering issuing their shares on the Market are one example. Companies issuing securities for the first time are involved in what is widely known as Initial Public Offering, or IPO. Prices in Primary Markets are often set in advance and in agreement between the underwriter and the issuing party.
The other type of Market is known as the Secondary market. The secondary market is simply the platform where all securities are traded after being initially offered on the Primary Market by underwriters. It is therefore, a market where investors purchase securities or assets from other investors, rather than from issuing companies themselves.