UNDERSTANDING
THE ROLE OF
THE FINANCIAL
MARKETS AND
INSTITUTIONS
Chapter 8
LEARNING
OBJECTIVES
After studying Chapter 8, you
should be able to:
01
Define financial markets.
02
Identify the participants in the financial
markets
03
Appreciate the importance of financial
markets as providers of funds to business
establishments.
LEARNING
OBJECTIVES
04
After studying Chapter 8, you
should be able to:
05
Enumerate and distinguish the types of
markets
IFamiliar with the categories of financial
institutions.
06
Understand the role of the stock market
LEARNING
OBJECTIVES
After studying Chapter 8, you
should be able to:
07
Know the kinds of stock market
08
Explain the reason for transactions in
stock market.
09
Discuss the role and operation of a stock
exchange
10
Know how securities are listed on the stock exchange
FINANCIAL MARKETS
the meeting place for people.
corporations and institutions that either
need money or have money to lend or
invest
Exist as a vast global network of
individuals and financial institution
Example: lenders, borrowers, owners of
public companies worldwide
PARTICIPANTS IN THE FINANCIAL MARKETS
Financial Markets
Public financial markets
national
state
local
government
Corporate financial
markets
large
corporation
IMPORTANCE OF
FINANCIAL MARKETS
To provide funds for short-term
operations and for new plant and
equipment
Corporations rely on the financial markets to provide funds for short-term
operations and for new plant and equipment. A firm may go to the
markets and raise financial capital by either borrowing money through a
debt offering of corporate bonds or short-term notes, or by selling
ownership in the company through an issue of common stock. When a
corporation uses the financial markets to raise new funds, the sale of
securities is said to be made in the primary market by way of a new issue.
After the securities are sold to the public (institutions and individuals).
They are traded in the secondary market between Investors. It is in the
secondary market that prices are continually changing as investors buy
and sell securities based on their expectations of a corporation's
Prospects. It is also in the secondary market that financial managers are
given feedback about their firm's performance. Those companies that
perform well and are rewarded by the market with high priced securities
have an easier time raising new funds in the money and capital markets
than their competitors. They are also able to raise funds at a lower cost.
Firms
(raise financial
capital)
Markets
Public
(institution and
individuals)
Secondary
markets
STRUCTURE AND FUNCTION OF THE FINANCIAL
MARKETS
1. Physical asset versus financial asset markets
A. PHYSICAL ASSET MARKET(ALSO CALLED TANGIBLE OR REAL ASSET MARKETS) ARE FOR
PRODUCTS SUCH AS WHEAT, AUTOS, REAL ESTATE, COMPUTERS
AND MACHINERY.
B. FINANCIAL ASSET MARKET- DEAL WITH FINANCIAL
INSTRUMENTS. DEAL WITH STOCKS. BONDS. NOTES AND
MORTGAGES. FINANCIAL MARKETS ALSO DEAL WITH DERIVATIVE
SECURITIES WHOSE VALUES ARE DERIVED FROM CHANGES IN THE
PRICES OF OTHER ASSETS.
STRUCTURE AND FUNCTION OF THE FINANCIAL
MARKETS
2. Spot markets versus
future markets
A. SPOT MARKETS- ASSET ARE
BOUGHT OR SOLD “ON THE SPOT
DELIVERY”.
B. FUTURE MARKETS- PARTICIPANTS
AGREE TODAY TO BUY OR SELL AN
ASSET AT SOME FUTURE DATE.
3. Money markets
versus Capital
markets
MONEY MARKETS- FUNDS ARE
BORROWED OR LOANED FOR
SHORT PERIODS (LESS THAN ONE
YEAR).
CAPITAL MARKETS- IT IS FOR
STOCKS AND FOR INTERMEDIATE
OR LONG-TERM DEBT (ONE YEAR
OR LONGER).
STRUCTURE AND FUNCTION OF THE FINANCIAL
MARKETS
4. Primary markets
versus Secondary
markets
PRIMARY MARKETS- CORPORATIONS
RAISE CAPITAL BY ISSUING NEW
SECURITIES.
SECONDARY MARKETS- SECURITIES
AND OTHER FINANCIAL MARKET ARE
TRADED AMONG INVESTORS AFTER
THEY HAVE BEEN ISSUED BY
CORPORATIONS.
5. Private markets
versus Public markets
PRIVATE MARKETS- ARE WORK
OUT DIRECTLY BETWEEN TWO
PARTIES.
PUBLIC MARKETSSTANDARDIZED CONTRACTS ARE
TRADED ON ORGANIZED
EXCHANGES.
FINANCIAL INSTITUTIONS
It is an establishment that conducts financial
transactions such as investments, loans and
deposits. Direct funds transfers are common
among individuals and small businesses and in
economies where financial markets and
institutions are less developed. But large
businesses in developed economies generally
find it more efficient to enlist the services of a
financial institution when it comes time to raise
capital.
Categories in financial institutions:
1.
Investment banks- An organization that
underwrites and distributes new investment
securities and helps businesses obtain
financing.
2.
Commercial banks- The traditional
department store of finance serving a variety
of savers and borrowers,
3. Financial services corporations- A firm that
offers a wide range of financial services,
including investment banking, brokerage
Operations, insurance and commercial
banking.
4. Credit unions- Cooperative associations
whose members are supposed to have a
common bond. such as being employees of
the same firm. Credit unions are Often the
cheapest source of funds available to
individual borrowers.
5. Pension funds- Retirement plans funded by
corporations or government agencies for their
workers and administered primarily by the
trust departments of commercial banks or by
life insurance companies
.
6. Life insurance companies- Savings in the
form of annual premiums; invest these funds
in stocks, bonds, real estate and mortgages;
and make payments to the beneficiaries of the
insured parties.
7. Mutual funds- Organizations that pool
investor funds to purchase financial.
instruments and thus reduce risks through
diversification. Money market funds are
mutual funds that invest in short-term. lowrisk securities and allow investors to write
checks against their accounts.
8. Exchange trade funds (ETF). Similar to regular
mutual funds and are Often operated by mutual fund
companies. An ETF buys a portfolio of stocks of a
certain type and then sells their own shares to the
public.
9. Hedge funds. Similar to mutual funds because they
accept money and use the funds to buy various
securities, but there are some important differences.
10. Private equity companies. Organizations that
operate much like hedge funds. But rather than
purchasing some of the stock of a firm, private equity
players buy and then manage entire firms.
STOCK MARKETS
A security that are already outstanding and
owned by the investors are usually bought
and sold through the secondary market.
Provide unique services and benefits to the
corporations, individual investors and
governments.
Business finance is concerned with the provision of funds for' investment in
business enterprise, whatever is invested in this way must be provided by an
investor and this means that the investor must forgo consumption and save
to provide the funds. Savers and the users of their funds come together in
the market for finance, where the normal rules of supply and demand apply
unless there is government interference with interest rates. The price of
money is the rate of interest paid for the use. If the demand for investment
funds is greater than the funds offered for investment by savers, then the
rate of interest will rise until people in the economy are induced to forgo
consumption and make their savings available for investment. The new
issues of securities are made available in the primary market. The securities
that are already outstanding and owned by the investors are usually bought
and sold through the secondary market, which is popularly known as stock
market.
In a stock market, purchases and sales of securities whether of government
or semi-government bodies or other public bodies and also shares and
debentures issued by joint stock companies are affected. The securities of
the government are traded in the stock market as a separate component
called gilt edged market. Government securities are traded outside the
trading wing in the form of over the counter sales or purchases. Another
component of stock market deals With trading in shares and debentures of
limited companies.
In the stock market. the outstanding issues are permitted to trade. In this
market, a stock or bond issue has already been sold to the public and it is
traded between Current and potential owners. The proceeds from sale in the
stock market do not go to the issuing organization but to the current owner
of the security. Once new issues have been purchased by investors. they
change hands in the stock market.
The primary middlemen in the stock market are brokers and dealers. The
distinction between them is the broker acts as an agent, whereas the dealer acts as
a principal in the transaction. Stock markets are said to reflect the health Of the
country's economy. On the Other hand, major economic indicators determine stock
market movements to a large extent. From a thorough analysis Of the various
economic indicators and its implications on the stock markets, it is known that stock
market movements are largely influenced by broad money supply, inflation,
credit/deposit ratio and fiscal deficit apart from political instability. Besides,
fundamental factors like corporate performance, industrial growth and so forth
always exert a certain amount Of influence on the stock markets. derivatives are
most modern financial instruments in hedging the risk. The individuals and firms
who wish to avoid or reduce risk can deal with Others who are willing to accept the
risk for a price. The common place where such transactions take place is called the
derivative market. Forwards. futures. options. swaps, caps and floor are some of the
commonly traded derivatives in the derivatives market.
KINDS OF STOCK MARKET
The Organized Stock Exchange. The stock exchanges will
have a physical location where stock buying and selling
transactions take place in the stock exchange floor (e.g., New
York Stock Exchange, Japan Nikkei, Shanghai Components,
NASDAQ, Philippine Stock Exchange, etc.).
The Over-the-Counter (OTC) Exchange. Where shares.
bonds and money market instruments are traded using a
system of computer screens and telephones.
REASONS FOR TRANSACTIONS IN STOCK MARKET
1.
Information Motivated Reasons. Information motivated investors
believe that they have superior information about a particular security
than other market participants. This information leads them to believe
that the security is not being correctly priced by the market. If the
information is good, this suggests that the security is currently
underpriced and investors with access to such information will want to
buy the security. On the other hand, if the information is bad. the
security will be currently overpriced and such investors will want to sell
their holdings of the security.
REASONS FOR TRANSACTIONS IN STOCK MARKET
1.
Liquidity Motivated Reasons. Liquidity motivated investors,
on the other hand, transact in the secondary market because
they are currently in a position of either excess or insufficient
liquidity. investors with surplus cash holdings (e.g., as a
result of inheritance) will buy securities, whereas investors
with insufficient cash (e.g., to purchase a car) will sell
securities.
STOCK EXCHANGE
Stock exchange is an organized secondary market where
securities like shares debentures of public companies,
government securities and bonds issued by municipalities.
public corporations. utility undertakings, port trusts and such
other local authorities are purchased and sold. In order to
bring liquidity, the stocks are traded systematically in a stock
exchange.
The stock exchange is an entity (a corporation or mutual organization) which is in
the business of bringing buyers and sellers of stocks and securities together. The
purpose of the stock exchange is to facilitate the exchange Of securities between
buyers and sellers. thus providing a market place, virtual or real. The stock
market does not have a physical presence, it is a virtual market. Gone are the
days when share brokers assembled in a place called the "trading ring" and
bought and sold shares, it was known as the outcry method. Technology has
enabled the ring to be located on a central computer. which has millions of buyers
and sellers attached to it through a telecommunication network. These buyers
and sellers indicate their intentions through a computer at home Or the Office,
their Own or their broker's. Buyers' and sellers' orders are matched by the central
computer. and if quantities and prices correspond, then a trade is set to be
executed. The entire process of sending the order to the stock exchange
computer, confirmation of order and execution, if any, is communicated within a
fraction of a second.
The stock exchange supplies a platform from which to buy and sell shares in
certain listed companies. It regulates the company's behavior through
requirements agreed upon by the company in order to be listed. This is called a
listing agreement which ensures that the company provides all the information
pertaining to its working from time to time, including events that affect its
valuation, such as mergers, amalgamations and such other sensitive matters.
Large volumes are possible in these markets because of two things. One is the
ease of settlements. The shares that are traded in are received and delivered
through an electronic entry in the books of buyers and sellers. The second
reason is the guarantee of trades. Sellers get their money, buyers get their
shares. The stock market is known as a barometer of the company’s economy.
The companies listed on stock exchanges collectively contribute to the
country’s GDP.
LISTING OF SECURITIES ON STOCK EXCHANGE
Listing means admission of securities to dealings on a recognized stock exchange of any
incorporated Company, central and state governments, quasi governmental and other
financial institutions/corporations, municipalities. electricity boards, housing boards and
so forth. The principal objective Of listing is to provide liquidity and marketability to
listed securities and ensure effective monitoring of trading for theList
benefit
of your
all company
1-3 ways
proposes
them.
participants in the market. A company desiring to get listing has to enter
intotoasolve
listing
agreement with the concerned stock exchange and is required to pay the specified
listing fees. Thereafter. The company is required to comply with all clauses of the listing
agreement and to send details of book closure, record dates, copies of annual report,
quarterly and half-yearly reports and cash statements to the respective stock exchange
where the securities are listed. A recognized stock exchange means a stock exchange
being recognized by the national government through the Securities and Exchange
Commission (SEC). Securities are bought and sold in recognized stock exchanges
through members who are known as brokers. The price at which the securities are
bought and sold on a recognized stock exchange is known as 0ffial quotation.
Solution
The securities of an entity may be listed at any of the
following stages:
At the time of public issue of shares or
debentures
At the time of rights issue of shares or debentures
At the time of bonus issue of shares
Shares issued on amalgamation or merger
In a stock exchange, a person who wishes to sell his
security is called a seller, and a person who is willing
to buy the particular stock is called the buyer. The
rate of stock depends on the simple law of demand
and supply.
Thank you!
Owen Manaay
Kathleen Joy Lurecha
BSA2