: : : Financial Markets : : :

With New Challenges and New Hopes, business units are under pressure to deliver the Best Services that should give maximum satisfaction but at minimum cost to the clients. This being the rule of the game, firms are required to develop strategies which would give them maximum profit by keeping their cost down. To implement the developmental plans from within the internal funds generated will not be sufficient enough.

Under this scenario, firms sought out for better solutions by way of capital raising from financial markets. In due course, these markets proved as a fertile ground for investment and lending. As financial markets have achieved new heights and their presence in the last two decades have helped an increasing number of firms to accomplish their business objectives.

The financial markets are markets that facilitate the raising of funds or the investment of assets, depending on viewpoint. They also facilitate handling of various risks. In simple terms, a financial market is a place where lenders who lend their excess of funds in the form of loan to borrowers who are in need or short of funds. The return on the investment is usually in the form of interest paid on the amount borrowed.

Functions of Financial Markets:

The financial markets came into existence to meet the financial needs of the investors. Based on these firm objectives, financial markets facilitate the investors to gather funds from a single place through a variety of instruments with yielded short-term or long-term benefits.

Borrowing and Lending:
The distribution of funds can be from one agent to another for either investment or consumption purposes is made by way of transfer of funds.

Price Determination:
Financial markets play a vital role in determining the price of the financial instrument. The market enables to set the prices of both a newly issued financial assets or for an existing stock of financial assets.

Information Aggregation and Coordination:
With a large flow of tradable instruments, financial markets acts as collectors and aggregators of information about financial asset values and the flow of funds from lenders to borrowers.

Risk Sharing:
Financial markets allow a transfer of risk from those who undertake investments to those who provide funds for those investments.

Liquidity:
By easy movement of funds the holders of the instruments can have the chance to hold or liquidate these at any point of time.

Low cost:
Financial markets reduce transaction costs and information costs.

Classifications of Financial Markets:

In the last decade the global financial markets and intermediaries have faced several crises. There have been abrupt declines in asset prices, major bouts of volatility in the foreign exchange markets, an exchange rate crisis together with a debt crisis in the emerging markets. Many factors have contributed in the restructuring of international finance which includes macroeconomic policies and management control failures and the transformation of different global markets in general. These changes increase competition in the markets of major countries that focused on liberalisation polices in the financial sector. The integration of capital markets, dominance of institutional investors, the development of new financial techniques and instruments, and the growth of the emerging markets are some of the key factors to that.

Markets are interrelated, and a problem in one market can have its source of fluctuations in the other corresponding markets. In the new generation the analysts in economics and business categorised the number of financial markets into four in general. They explored the vast number of markets in the modern economy as markets for goods and services, financial assets, money balances, and resources. Changes in one part of the economy are rapidly transmitted to other parts through financial markets. The ability of financial markets to transmit this is highlighted in the market for foreign exchange.

The market for instruments (also called securities) can be broadly classified into two categories:
1. Primary Markets
2. Secondary Market (also called After market)

Primary Market:
A primary market is the financial market for the initial issue and placement of securities. Unlike the secondary markets, financial markets are not governed by any regulatory bodies and so there is no organised stock exchange for trading these instruments. Organizations that need funds contact their investment banker who typically assembles a syndicate of securities dealers that will sell the new stock issue. Securities dealers see this as the wholesale part of their business. This process of selling the new stock issues to prospective investors in the primary market is called underwriting. The securities that they sell are called initial public offerings (IPOs). Dealers usually earn a commission that is built into the price of the security offering, that is, it is not apparent unless you read the prospectus in detail. This is contrasted with the retail part of the business, which is acting as an intermediary between buyers and sellers of securities in the secondary.

Secondary Market:
The secondary market (also called aftermarket) is the financial market for trading of already issued securities. In the secondary market, securities are sold by and transferred from one investor to another. It is therefore important that the secondary market be highly liquid and transparent. The eligibility of shares and bonds for trading in the secondary market is regulated through financial supervisory authorities and the rules of the market place in question, which could be a stock exchange. Stock brokers see the secondary market as the retail part of their business. They are dealing with many clients and many relatively small transactions. This can be contrasted with the primary market in initial public offerings which can be seen as the wholesale side of their business.

The financial markets may fall into any of the below markets depending on the nature of the instrument. Depending on these features financial markets can be classified into

1. Capital markets: The capital market is the market for long-term loans and equity capital. Companies and the government can raise funds for long-term investments via the capital market. The capital market includes the stock market, the bond market, and the primary market. Securities trading on organized capital markets are monitored by the national government; new issues are approved by authorities of financial supervision and monitored by participating banks. Thus, organized capital markets are able to guarantee sound investment opportunities. The capital market can be contrasted with other financial markets such as the money market which deals in short term liquid assets, and futures markets which deal in commodities contracts.

a. Stock markets: A stock market is a market for the trading of publicly held company stocks or shares and associated financial instruments, including stock options, convertibles and stock index futures. Traditionally such markets were open-outcry where trading occurred on the floor of an exchange. These days increasingly the markets are cyber-markets with buying and selling occurring via online real-time matching of orders placed by buyers and sellers.

Many years ago, worldwide, buyers and sellers were individual investors and businessmen. These days markets have generally become institutionalized, that is, buyers and sellers are large institutions like pension funds, insurance companies, mutual funds or banks. This rise of the institutional investor has brought growing professionalism to all aspects of the markets. The movements of the prices in a market or section of a market are captured in price indices called Stock Market Indices. There are stock markets in most developed economies, with the world's biggest markets being in the USA, Japan, the UK, and Europe. There are global stock-market indices that shape the choices and distribution of funds of institutional investors. The character of markets around the world varies, for example with the majority of the shares in the Japanese market being closely held with financial companies and industrial corporations, compared with the structures of ownership in the USA or the UK.

b. Bond markets: A bond or debenture is a debt instrument that obligates the issuer to pay to the bondholder the plus interest. Thus, a bond is essentially an I.O.U. (I owe you contract) issued by a private or governmental corporation -- that corporation "borrows" the face amount of the bond from its buyer, pays interest on that debt while it is outstanding, and then "redeems" the bond by paying back the debt. Bonds are securities but differ from shares of stock in that stock is an ownership interest (termed "equity"), but bonds are merely "debt": Therefore a stockholder is an owner, but a bond-holder is merely a creditor.

Junk bond: Junk bond is a business term referring to a debt instrument (bond) that has a higher risk of defaulting. They typically pay high yields in order to make them attractive to investors. The term "junk" is considered pejorative, and these instruments are more often referred to as high yield bond or non-investment grade bonds. In modern economies, debt is bought and sold in the form of bonds traded in organized markets. The price of a bond is determined by numerous factors, including the interest rate, the term and the degree of risk associated with the underlying assets.

Zero-coupon bond: Zero-coupon bonds are bonds which do not pay interest payments (also known as coupon payments). The holder of a zero coupon bond is entitled to receive a single payment, usually of a specified sum of money at a specified time in the future. Some zero coupon bonds are inflation indexed, and so the amount of money that will be paid to the bond holder is calculated to have a set amount of purchasing power rather than a set amount of money, but the majority of zero coupon bonds pay a set amount of money. In contrast, an investor who has a regular bond receives income from coupon payments, which are usually made semi-annually. The investor also receives the principal or face value of the investment when the bond matures.

2. Money markets: The money market is a general term for the markets in which banks lend to and borrow from each other, trade financial instruments such as Certificates of Deposit (CDs) or enter agreements such as Re-purchase agreements and Reverses. The market normally trades in maturities up to one year. It provides short to medium term liquidity in the global financial system. Derivatives of the money market include Forward Rate Agreements (FRA’s) and futures. Trading takes place between banks in the money centres. Basically rooted in New York and London, Chicago, Frankfurt, Singapore, Hong Kong, Tokyo, Toronto and Sydney are the major destinations of trade.

3. Derivatives markets: A derivatives market is any market for a derivative, which is a contract which specifies the right or obligation to receive or deliver future cash flows based on some future event such as the price of an independent security or the performance of an index. Derivatives markets can be standardized or non-standardized. One derivatives market is for standardized stock options, a market where parties can buy or sell, call or put options on a secondary market. Non-standardized derivatives instruments, such as naked warrants issued directly by financial institutions to a secondary market, also exist. Other derivative markets include those for Interest Rate Swaps, Credit Default Swaps and Options and forwards on foreign exchange.

4. Futures markets: Futures markets play important role in determining the inventory decisions in the cash market. The futures market is the nerve centre for collection and dissemination of information about the agent’s expectations of future cash market. It performs the price insurance and price discovery functions. The latter function enables the traders to make rational choices about inventory management. This results in reduction in volatility of cash prices. The ability of futures markets to reduce risks associated with price variability and stock holding through hedging is probably their most important role. The argument of risk reduction through hedging primarily rests on the observation that the spot and futures markets move together, so losses in one market can be made good through gains in other market. Also the variability of basis is less than the variability of either underlying cash market or futures market. Even in well functioning markets the movement of spot and futures prices is not perfectly parallel, so the trader can only reduce risks through placing opposite positions in two markets.

Futures Contract: A futures contract is a binding agreement between a seller and a buyer to make (seller) and to take (buyer) delivery of the underlying commodity (or financial instrument) at a specified future date with agreed upon payment terms. Most futures contracts don’t actually result in delivery of the underlying commodity. Instead, most traders find it advantageous to settle their futures market obligation by selling the contract (in the case of a contract that was purchased initially) or by buying it back (in the case of a contract that was sold initially). The trader then completes the actual cash transaction in his or her local cash market.

5. Insurance markets: Insurance is the business of providing protection against financial aspects of risk, such as those to property, life, health and legal liability. It is one method of a greater concept known as risk management. The main insurance covered sectors are Auto, Business, Home, Life and Property. Modern insurance markets that are relatively free from regulatory constraints on prices and risk classification exhibit pervasive evidence of competitive conduct and performance. Insurers vary substantially in terms of price, underwriting standards, and service. Competition creates strong incentives for insurers to forecast costs accurately and to price and underwrite each policyholder so as to avoid adverse selection. Thus, competition produces highly refined underwriting and classification systems. Prices vary across insurers in relation to the stringency of classification and underwriting standards.

6. Forex markets: The FOREX or Foreign Exchange market is the largest financial market in the world, with a volume of more than $1.5 trillion daily, dealing in currencies. Unlike other financial markets, the Forex market has no physical location, no central exchange. It operates through an electronic network of banks, corporations and individuals trading one currency for another. The lack of a physical exchange enables the Forex market to operate on a 24-hour basis, spanning from one zone to another across the major financial centres. Traditionally, investors' only means of gaining access to the foreign exchange market was through banks that transacted large amounts of currencies for commercial and investment purposes. Trading volume has increased rapidly over time, especially after exchange rates were allowed to float freely.

Exchange Rate: In finance, the exchange rate between two currencies specifies how much one currency is worth in terms of the other. For example an exchange rate of 120 Japanese Yen to the Dollar means that ¥120 is worth the same as $1. An exchange rate is also known as a foreign exchange rate, or FX rate. An exchange rate quotation is given by stating the number of units of a price currency can be bought in terms of a unit currency. For example in a quotation that says the Euro-United States Dollar exchange rate is 1.2 dollars per euro, the price currency is the dollar and the unit currency is the euro. The usual unit currency varies by geographic location. Quotes using the US dollar as the unit currency are known as direct or price quotation and used in any other country. If a unit currency is strengthening or appreciating (i.e. if the currency is becoming more valuable) then the exchange rate number increases. Conversely if the price currency is strengthening, the exchange rate number decreases and the unit currency is depreciating.

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