UNIVERSITY OF CALOOCAN CITY

PROGRAM: BSBA- FINANCIAL MANAGEMENT

COURSE: FINANCIAL MARKETS

TOPIC 2
FINANCIAL MARKETS

INTRODUCTION:

This chapter, students will learn about financial markets, primary

markets, secondary markets, money market, and capital markets.
They will acquainted with the different money markets and capital
markets. In addition, market for government securities will be
discussed. Market offerings and private placements will be
differentiated. The students will also have a preview of the different
money market and capital market instruments dealt with in these
markets., which will be discussed fully in the next topic.

Financial Market
Financial markets refer broadly to any marketplace where
securities trading occurs, including the stock market, bond market,
forex market, and derivatives market. Financial markets are vital to
the smooth operation of capitalist economies.

7 Functions of Financial Markets

1. Price Determination

The financial market performs the function of price discovery of

the different financial instruments traded between the buyers and
the sellers on the financial market. The prices at which the financial
instruments trade in the financial market are determined by
the market forces, i.e., demand and supply.
So the financial market provides the vehicle by which the prices are
set for both financial assets which are issued newly and for the
existing stock of the financial assets.
 2. Funds Mobilization

Along with determining the prices at which the financial instruments

trade in the financial market, the required return out of the funds
invested by the investor is also determined by participants in the
financial market. The motivation for persons seeking the funds is
dependent on the required rate of return, which the investors
demand.

Because of this function of the financial market only, it is signaled

that funds available from the lenders or the investors of the funds will
get allocated among the persons who need the funds or raise funds
through the means of issuing financial instruments in the financial
market. So, the financial market helps in the mobilization of the
investors’ savings.

3. Liquidity

The liquidity function of the financial market provides an opportunity

for the investors to sell their financial instruments at their fair
value prevailing in the market at any time during the working hours
of the market.
In case there is no liquidity function of the financial market. The
investor forcefully have to hold the financial securities or the financial
instrument until the conditions arise in the market to sell those assets
or the issuer of the security is obligated contractually to pay for the
same, i.e., at the time of maturity in debt instrument or at the time of
the liquidation of the company in case of the equity instrument is
until the company is either voluntarily or involuntarily liquidated.
Thus, investors can sell their securities readily and convert them into
cash in the financial market, thereby providing liquidity.

4. Risk sharing

The financial market performs the function of risk-sharing as the

person who is undertaking the investments is different from the
persons who are investing their fund in those investments.
With the help of the financial market, the risk is transferred from the
person who undertakes the investments to those who provide the
funds for making those investments.

5. Easy Access

The industries require the investors to raise funds, and the investors
require the industries to invest their money and earn the returns from
them. So the financial market platform provides the potential buyer
and seller easily, which helps them save their time and money in
finding the potential buyer and seller.

6. Reduction in Transaction Costs and Provision of the

Information

The trader requires various types of information while doing the

transaction of buying and selling the securities. For obtaining the
same time and money is required.

But the financial market helps provide every type of information to

the traders without the requirement of spending any money by
them. In this way, the financial market reduces the cost of the
transactions.

7. Capital Formation

Financial markets provide the channel through which the new

investors’ savings flow in the country, which aids in the country’s
capital formation.
Classification Of Financial Markets
The financial market is a platform or an arrangement in which
various types of financial instruments are bought and sold among
market participants. These instruments may be bonds, commodities,
stocks, derivatives, currencies, etc. The buyers and sellers meet in
these platforms to exchange the assets. They form an important part
of the financial market and help the participants achieve investment
objectives, assess the risk tolerance and develop an outlook towards
the market.

The classification of international financial markets can be of four

categories: –

1. By Nature of Claim

Markets are categorized by the type of claim the investors have on

the entity’s assets in which they have made the investments. There
are broadly two kinds of claims, i.e., fixed and residual. Based on the
nature of the claim, there are two kinds of markets.

A. Debt Market

A debt market is when debt instruments such

as debentures, bonds, etc., are traded between investors.
Such instruments have fixed claims, i.e., their share in the
entity’s assets is restricted to a certain amount. In addition,
these instruments generally carry a coupon rate,
commonly known as interest, which remains fixed over
some time.

B. Equity Market

In this market, equity instruments are traded. As the

name suggests, equity refers to the owner’s capital in the
business. It thus has a residual claim, implying that
 whatever is left in the industry after paying off the fixed
liabilities belongs to the equity shareholders, irrespective of
the face value of their shares.

2. By Maturity of Claim

While investing, time plays an important role as the amount of

investment depends on the time horizon of the acquisition. The time
also affects the risk profile of an investment. An investment with a
lower time carries a lower risk than an investment with a higher
period.

There are two types of market-based on the maturity of claim:

A. Money Market

The Money market is for short-term funds, where the

investors who intend to invest for not longer than a year enter
into a transaction. This market deals with monetary assetssuch
as treasury bills, commercial paper, and certificates of deposits.
The maturity period for all these instruments does not exceed a
year.

Since these instruments have a low maturity period, they

carry a lower risk and a reasonable rate of return for the investors,
generally in interest.

B. Capital Market

The capital market is when instruments with medium- and

long-term maturity are traded. It is the market where the
maximum interchange of money happens. It helps companies
access money through equity capital, preference share
capital, etc. It also provides investors access to invest in the
company’s equity share capital and be a party to
the profits earned by the company.
This market has two verticals:

• Primary Market – Primary market refers to the market where the

company lists security for the first time or the already listed
company issues fresh security. It involves the company and
the shareholders transacting with each other. In addition, the
company receives the amount paid by shareholders for the
primary issue. For the primary market, there are two major types
of products, viz. Initial Public Offer (IPO) or Further Public Offer
(FPO).
• Secondary Market – Once a company gets the security listed,
the deposit becomes available to be traded over the
exchange between the investors. The market that facilitates
such trading is the secondary market or the stock market.

In other words, it is an organized market where securities trading

occurs between investors. Investors could be individuals, merchant
bankers, etc. Transactions of the secondary market do not impact
the company’s cash flow position; as such, the receipts or payments
for such exchanges are settled amongst investors without the
company being involved.

3. By Timing of Delivery

In addition to the above-discussed factors, such as time horizon,

nature of the claim, etc., another factor has distinguished the
markets into two parts, i.e., timing of delivery of the security. This
concept generally prevails in the secondary market or stock market.
Depending on the timing of delivery, there are two types of markets:

A. Cash Market

In this market, transactions are settled in real-time.

Therefore, it requires the total amount of investment to be paid
by the investors, either through their funds or borrowed capital,
generally known as margin, which is allowed on the present
holdings in the account.
 B. Futures Market

In this market, the settlement or delivery of security or

commodity occurs later. Therefore, transactions in such markets
are generally cash-settled instead of settled delivery. For
trading in the futures market. Rather, a margin going up to a
certain percentage of the asset amount is sufficient to trade in
the asset.

4. By Organizational Structure

Markets are also categorized based on the market structure, i.e.,

how transactions are conducted. There are two types of the
markets, based on organizational structure: –

A. Exchange-Traded Market

An exchange-traded market is a centralized market

that works on pre-established and standardized
procedures. In this market, the buyer and seller do not
know each other. Transactions are entered with the help
of intermediaries, who are required to ensure the
settlement of the transactions between buyers and sellers.
There are standard products that are traded in such a
market. Therefore, they cannot need specific or
customized products.

B. Over-the-Counter Market

This decentralized market allows customers to trade

customized products based on their requirements.

In these cases, buyers and sellers interact with each

other. Generally, over-the-counter market transactions
involve hedging foreign currency exposure, exposure
to commodities, etc. These transactions occur over-the-
counter as different companies have different maturity
 dates for debt, which generally does not coincide with
the settlement dates of exchange-traded contracts.

Over time, financial markets have gained

importance in fulfilling the capital requirements for
companies and providing investment avenues to the
investors in the country. Financial markets
offer transparent pricing, high liquidity, and investor
protection from frauds and malpractices.

Types of Investors
Angel Investors

An angel investor is a high-net-worth private individual that provides

financial capital to a startup or entrepreneur. The capital is often
provided in exchange for an equity stake in the company. Angel
investors can provide a financial injection either once or on an
ongoing basis. An angel investor typically provides capital in the early
stages of a new business, when risk is high. They often use excess cash
on hand to allocate towards high-risk investments.

Venture Capitalists

Venture capitalists are private equity investors, usually in the form of a

company, that seek to invest in startups and other small businesses.
Unlike angel investors, they do not seek to fund businesses in the early
stages to help get them off the ground, but rather look at businesses
that are already in the early stages with a potential for growth. These
are companies often looking to expand but not having the means to
do so. Venture capitalists seek an equity stake in return for their
investment, help nurture the growth of the company, and then sell
their stake for a profit.

P2P Lending

P2P lending, or peer-to-peer lending, is a form of financing where loans

are obtained from other individuals, cutting out the traditional
middleman, such as a bank. Examples of P2P lending include
crowdsourcing, where businesses seek to raise capital from many
investors online in exchange for products or other benefits.

Personal Investors

A personal investor can be any individual investing on their own and

may take many forms. A personal investor invests their own capital,
usually in stocks, bonds, mutual funds, and exchange-traded funds
(ETFs). Personal investors are not professional investors but rather those
seeking higher returns than simple investment vehicles, like certificates
of deposit or savings accounts.

Institutional Investors

Institutional investors are organizations that invest the money of other

people. Examples of institutional investors are mutual funds, exchange-
traded funds, hedge funds, and pension funds. Because institutional
investors raise large amounts of capital from many investors, they are
able to purchase large amounts of assets, usually big blocks of stocks.
In many ways, institutional investors can influence the price of assets.
Institutional investors are large and sophisticated.