FINANCIAL MARKETS, FINANCIAL INSTITUTIONS AND FINANCIAL INSTRUMENTS
Financial markets
Financial market are institutions or arrangements that facilitate the exchange of financial assets, including deposits and loans, corporate stocks and bonds, government bonds, and more exotic instruments such as options and futures contracts. They are mechanism in our society for converting public savings into investments such as buildings, machinery, infrastructure and inventories of goods and raw materials. This enables the economy to grow; new jobs are created and living standards to rise. Financial markets therefore perform the essential economic function of channeling funds from economic units which have surplus funds (net savers) to economic units with a net deficit of funds (investors).
Classification of financial markets
There are several methods of classifying financial markets. Some are as follows:
i. Classification of the markets based on the type of instrument or service as follows:
Debt markets
This is the most familiar type of market. In debt markets, the lenders provide funds to borrowers for some specified period of time. In return for the funds, the borrower agrees to pay the lender the principal loan plus some specified amount of interest.
Debt markets are used by:
Individuals to finance purchases such as houses, cars home appliances e.t.c.
Corporate borrowers to finance working capital and new equipment
The central and local governments to finance various public expenditures
Debt instruments include bonds, mortgages and the various types of bank loans. These are contractual agreements by the borrower to pay the holder of the instrument fixed amounts of money at regular intervals until the maturity date, when the final payment is made. The regular payments contain elements of both principal and interest payments.
Equity markets
This is the market for raising funds by issuing equities such as common stock. Equities are claims to share in the net income and the assets of a business. Equities usually make periodic payments in form of dividends to their holders. Holders are residual claimants in that the corporate must pay all its debt holders before its equity holders. Equities usually have no maturity dates.
(c) Financial service markets
These are markets where individuals and corporate can purchase services that enhance the working of the debt and equity markets.
Bank for example; provide depositors many services in addition to paying them interest on their deposits. These include money transmission services, safe deposit facilities, payment services e.t.c. Thus, in addition to participating in the debt market, by issuing loans banks also provide financial services that provide „convenience‟ to consumers in various ways.
Another financial service is brokerage services. Brokers are intermediaries who compete for the right to help people buy or sell something of value. Stockbrokers help individuals to buy or sell assets such as stocks and bonds. As intermediaries, brokers receive a fee for performing the services of matching buyers and sellers of assets. Dealers on the other hand, buy and sell securities on their portfolio, not just matching buyers and sellers.
Finally, financial service markets provide consumers, businesses, and governments with financial risk management services, that is, protection against life, health, property and income risks through sale of various insurance policies.
ii. A broad classification that distinguishes between primary and secondary market
Primary market
The primary market is used for trading of new securities that have never before been issued. Its primary function is raising capital to support new investments or corporate expansions. The best example of a primary market is the market for corporate initial public offers (IPOs) which are used to sell company shares to the public for the first time.
Secondary markets
These are markets that deal in securities which were issued previously. The chief function of a secondary market is to provide liquidity to investors, that is, provide an avenue for converting financial instruments into ready cash. Examples of secondary markets are markets for stocks and shares and that of long-term bonds.
iii. A classification of markets based on the term to maturity and liquidity of the instrument.
This method categories financial market into:-
- Money market
- Capital markets
Money markets are financial markets that are used for trading of short-term debt instruments, generally those with original maturity of less than one year. The money market is the place where individuals and institutions with temporary surpluses of funds meet the needs of borrowers who have temporary fund shortages. Thus, the money markets enable economic units to manage their liquidity positions. A security with a maturity of period of less than one year is considered a money market instrument.
One principal function of the money market is to finance the working capital needs of corporations and to provide governments with short-term funds as they wait to collect tax. The money market also supplies funds for speculative buying of securities and commodities.
Capital markets
The capital market is designed to finance long-term investments by businesses, governments and households. Capital market instruments are mainly longer term securities (those with original maturities of more than one year) and equities. Examples include bonds and shares traded on the stock exchange.
