Financial Markets and Their Role in Economy
Financial Markets and Their Role in Economy
Financial Markets and Their Role in Economy
Submitted by:
Awan
Registration No.:
Class:
Submitted to:
Muzammal Shahzad
7468-FMS/MBA/F16
MBA-18(B)
Sir Sagheer Ahmed
Financial Markets:
The financial market is a broad term describing any marketplace where trading of securities
including equities, bonds, currencies and derivatives occurs. Although some financial
markets are very small with little activity, some financial markets including the New York
Stock Exchange (NYSE) and the forex markets trade trillions of dollars of securities daily.
Investors have access to a large number of financial markets and exchanges representing a
vast array of financial products. Some of these markets have always been open to private
investors; others remained the exclusive domain of major international banks and financial
professionals until the very end of the twentieth century.
Following are the major types of financial markets:
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2
3
4
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Capital Markets
Money Market
Cash or Spot Market
Derivatives Markets
Foreign Exchange Market
6 Interbank Market
1 Capital Markets:
A capital market is one in which individuals and institutions trade financial securities.
Organizations and institutions in the public and private sectors also often sell securities on
the capital markets in order to raise funds. Thus, this type of market is composed of both the
primary and secondary markets. Primary markets are those in which stocks or bonds are
issued for the first time and in secondary markets existing securities are traded. Any
government or corporation requires capital (funds) to finance its operations and to engage in
its own long-term investments. To do this, a company raises money through the sale of
securities - stocks and bonds in the company's name. These are bought and sold in the capital
markets.
Stock Markets
Stock markets allow investors to buy and sell shares in publicly traded companies. They are
one of the most vital areas of a market economy as they provide companies with access to
capital and investors with a slice of ownership in the company and the potential of gains
based on the company's future performance.
Bond Markets
A bond is a debt investment in which an investor loans money to an entity (corporate or
governmental), which borrows the funds for a defined period of time at a fixed interest rate.
Bonds can be bought and sold by investors on credit markets around the world. This market
is alternatively referred to as the debt, credit or fixed-income market. It is much larger in
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nominal terms that the world's stock markets. The main categories of bonds are corporate
bonds, municipal bonds, and U.S. Treasury bonds, notes and bills.
2 Money Market:
The money market is a segment of the financial market in which financial instruments with
high liquidity and very short maturities are traded. The money market is used by participants
as a means for borrowing and lending in the short term, from several days to just under a
year. Money market securities consist of negotiable certificates of deposit (CDs), banker's
acceptances, U.S. Treasury bills, commercial paper, municipal notes, Eurodollars, federal
funds and repurchase agreements (repos). Money market investments are also called cash
investments because of their short maturities.
4 Derivatives Markets:
The derivative is named so for a reason: its value is derived from its underlying asset or
assets. A derivative is a contract, but in this case the contract price is determined by the
market price of the core asset. If that sounds complicated, it's because it is. The derivatives
market adds yet another layer of complexity and is therefore not ideal for inexperienced
traders looking to speculate. However, it can be used quite effectively as part of a risk
management program. Examples of common derivatives are forwards, futures, options,
swaps and contracts-for-difference (CFDs).
6 Interbank Market:
The interbank market is the financial system and trading of currencies among banks and
financial institutions, excluding retail investors and smaller trading parties. While some
interbank trading is performed by banks on behalf of large customers, most interbank trading
takes place from the banks' own accounts.
Sometimes the company may decide not to pay dividend in cash but rather by issuing
additional shares to the existing shareholders. An investor may also decide to sell his/her
shares to make a capital gain. The receipt of dividend, bonus shares and capital gains from
selling shares all amount to wealth creation by the investor.
Large financial markets with lots of trading activity provide more liquidity for market
participants than thinner markets with few available securities and participants and thus
limited trading opportunities. The U.S. financial system is generally considered to be the
most, well developed in the world. Daily transactions in the financial markets, both the
money (short term, a year or less) and capital (over a year) markets, are huge. Many financial
assets are liquid; some may have secondary markets to facilitate the transfer of existing
financial assets at a low cost.
Financial markets play a critical role in the accumulation of capital and the production of
goods and services. The price of credit and returns on investment provide signals to
producers and consumers, financial market participants. Those signals help direct funds
(from savers, mainly households and businesses) to the consumers, businesses, governments,
and investors that would like to borrow money by connecting those who value the funds
most highly (i.e., are willing to pay a higher price, or interest rate), to willing lenders. In a
similar way, the existence of robust financial markets and institutions also facilitates the
international flow of funds between countries.
In addition, efficient financial markets and institutions tend to lower search and transactions
costs in the economy. By providing a large array of financial products, with varying risk and
pricing structures as well as maturity, a well-developed financial system offers products to
participants that provide borrowers and lenders with a close match for their needs.
Individuals, businesses, and governments in need of funds can easily discover which
financial institutions or which financial markets may provide funding and what the cost will
be for the borrower. This allows investors to compare the cost of financing to their expected
return on investment, thus making the investment choice that best suits their needs. In this
way, financial markets direct the allocation of credit throughout the economy and facilitate
the production of goods and services.
In many developing nations, limited financial markets, instruments, and financial
institutions, as well as poorly defined legal systems, may make it more costly to raise capital
and may lower the return on savings or investments. Limited information or lack of financial
transparency mean that information is not as readily available to market participants and
risks may be higher than in economies with more fully-developed financial systems. In
addition, it is more difficult to hold a diversified portfolio in small markets with only a
limited selection of financial assets or savings and investment products. In such thin financial
markets with little trading activity and few alternatives, it may be more difficult and costly to
find the right product, maturity, or risk profile to satisfy the needs of borrowers and lenders.
1 http://www.investopedia.com/walkthrough/corporate-finance/1/financial-markets.aspx
2 http://www.frbsf.org/education/publications/doctor-econ/2005/january/financial-marketseconomic-performance/
3 http://www.waifemcbp.org/v2/dloads/THE%20ROLE%20OF%20FINNCIAL
%20MARKET.pdf