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Financial Markets & Institutions
Finance > Financial Markets & Institutions
Table of Contents
Abstract
Keywords
Overview
Viewpoints
Terms & Concepts
Bibliography
Suggested Reading
Abstract
Financial markets are an important contributor to the economy
and provide an environment for investors to make decisions and
act on investment opportunities. Various financial institutions
are a part of financial markets and offer not only opportunity
for buyers and sellers but play a role as major employers of
finance professionals. Success in investing requires having an
understanding of the financial markets and the products that
are available for investing. These products can include stocks,
bonds, mutual funds and international securities. Investors must
weigh the risk and reward of these products and compare them
to investing in other items or choosing to do nothing. Participation in financial markets and working with financial institutions
requires understanding how they work and the process of investing. While this knowledge doesn’t guarantee success, it can
prevent investors from making avoidable mistakes.
Statistics (www.bls.gov) the financial services industry includes
banking, insurance and securities and commodities trading.
The industry also includes the real estate and rental and leasing
sector. The finance and insurance institutions engage in financial
transactions that create financial instruments, dispose of them or
change ownership. The Bureau of Labor Statistics has identified
three activities related to financial transactions including:
• “Raising funds by taking deposits and/or issuing securities
and, in the process, incurring liabilities.
•
Pooling of risk by underwriting insurance and annuities.
•
Providing specialized services, facilitating or supporting
financial intermediation, insurance, and employee benefit
programs.”
Real estate, rental and leasing transactions have to do with the
“use, sale or rental” of “tangible or intangible assets.” Simply
put, financial markets are a place where the buying and selling
of financial instruments is facilitated and where access to market
demand is provided.
Knowledge Necessary for Savvy Investing
Groz (1999) suggested ten categories of knowledge one needs to
become a “savvy” investor. These categories are:
• The Products
• The Players
• The Procedures
• The Rules
• The Regulators
• Risk And Performance
Overview
• Resources
Successful investors become educated about the environment in
which they operate. Part of that success is in understanding financial markets and institutions, to understand what investments
are available, and to understand how and where to invest and
the basic rules of investing. According to the Bureau of Labor
• Costs
• Scams
• Jargon
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Financial Markets & Institutions
Keywords
Essay by Marlanda English, Ph. D.
International Exchanges
Financial Institutions
There are international markets for stocks and bonds and there
are exchanges that govern those financial markets. Some large
international exchanges include the London Stock Exchange,
the Deutsche Borse Exchange in Franfurt, the Tokyo Stock
Exchange and the Hong Kong Stock Exchange (Kansas, 2005).
Globalization is increasing the connection of economies that
were previously separated. As a result, the financial markets in
one part of the world can have a powerful effect on markets in
another part of the world.
Financial Market
Electronic Communications Networks
Bond
Equity
Financial Industry
Mutual Funds
Security
Stock
This list is an overwhelming one and it could take an investor
a lifetime to master many of these subjects. Groz’s last point,
jargon, is an important concept. Every industry has its own language and shorthand. The financial industry is no different, other
than its jargon can be very complex and difficult to understand.
Some financial terms come from very old concepts and have
survived over time and may not have a meaning similar to a current situation or item. The complexity of the language of finance
frightens many would-be investors and may cause novice investors to rely heavily on advisors to assist in understanding and
navigating the financial system.
Financial Stock Markets
There are two major financial markets for stocks in the United
States. The New York Stock Exchange and the Nasdaq Stock
Market are the places where public companies list their stock.
The oldest is the New York Stock Exchange which began in
1792 (Kansas, 2005). At this point in history, brokers who served
as mediators between buyers and sellers, offered to trade securities and stock for a commission. The New York Stock Exchange
started with only five securities but now lists stocks that value
over $20 trillion (Kansas, 2005). There are many famous companies, old and new, that have stock listed on the New York
Stock Exchange. Large corporations like Exxon Mobil, General
Electric and IBM are listed and have long, established histories
as companies. Others like Verizon Communications are more
recent entries that resulted from mergers in their industries. The
NASDAQ has been home to companies that are in technology or
newer companies and includes tech giants Microsoft and Intel.
While the New York Stock Exchange (NYSE) relies on specialists who trade stocks, the NASDAQ uses market traders who
specialize in a grouping of similar stocks (Kansas, 2005). An
individual investor deals with a broker to invest in stocks on the
NYSE who interact with floor brokers and post specialists or
“referees” (Kansas, 2005).
A new trend in financial markets trading stocks are ECNs or
electronic communications networks which allow large buyers
and sellers a convenient way to find each other (Kansas, 2005).
Investors like to know the general direction of financial markets.
Certain types of information can provide an average of how
major stocks in major industries are faring. One such index is the
Dow Jones Industrial Average. The Dow Jones Industrial Average (DJIA) gives investors an idea of how things are going in a
market and can be used in concert with other information. Other
indexes include the Standard & Poor’s “500 stock index” of blue
chip companies (Kansas, 2005).
Bull & Bear Markets
Investors realize that things change with financial instruments
and are always looking for growth stocks. These are stocks that
tend to perform well or grow, even when the economy is not
very good (Kansas, 2005). Two symbols of the rising and falling fortunes of financial markets are the bear and the bull. The
bull symbolizes a time when the market is going higher while
the bear signifies a “downward trend” in stocks (Kansas, 2005).
The common anecdotal reason for these symbols is that bulls
move their horns in an upward motion when going for the kill
and bearskin traders would sell the skins before they were caught
hoping that they would be able to deliver them later. When the
DJIA declines 20% or more it is considered to be a bear market.
Similarly, if the market were to increase 20% or more it would
be considered a bull market.
Kansas (2005) notes several characteristics of bull and bear markets. A bull market is characterized by rising stock prices, an
increase in earnings, low inflation and interest rates. Meanwhile,
a bear market is characterized by falling stock prices and earning,
rising inflation and high or rising interest rates. Rapid changes in
the financial markets make the action dynamic and exciting for
those involved. However, at the same time, financial markets can
be difficult to follow and even scary. In one moment, an investor
can make a fortune and lose it in the next moment. Many say
that is why there are brokers and traders. These professionals
may enjoy gambling with someone else’s money but can’t take a
chance on their own.
How Financial Markets Work
Groz (1999) defines the basic products in financial markets to be
stocks, mutual funds, bonds, options, and futures. These prod-
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Financial Markets & Institutions
ucts are typically managed and affected by a number of players
including the investor as well as brokers, money managers,
financial planners and information providers. All players can
be adversely impacted on returns except information providers
who are likely to disclaim or explain away any results that aren’t
entirely favorable. Some players assume multiple roles. Investors have to look carefully for conflicts of interest when taking
the advice of an entity that plays multiple roles. In fact, there is a
sales opportunity for entities that play multiple roles. Most financial services products require gathering personal information
from the consumer and that information may be shared amongst
all of the entities that a company owns regardless of what they
sell. Investors should read privacy statements from companies
and act decisively to ensure that information is not shared without their consent and to minimize additional sales prospecting
that is unwanted.
Part of being a smart investor is to be an educated investor. Groz
(1999) feels that it is difficult for the average investor to get
good information about financial markets and investing. However, Groz recommended what he called “financial information
supermarkets” such as Yahoo or InvestTools.com. Free information is also available from the companies themselves, which are
listed on the stock exchanges, from actual stock exchanges such
as the NYSE and from investor associations. Much of this information is free. There are also magazines and other publications
that strictly cover financial issues. The interested investor may
want to become an avid reader of these to become familiar with
the language and to follow the activity. The use of “intelligent
agents” or technological robots that search endlessly for specific
information on search engines and through databases can also be
valuable software tools for investors (Groz, 1999) Small investors may choose to join investment clubs to share the burden of
learning about financial markets and institutions and to increase
the pool of money to invest (Kansas, 2005).
Stocks
Stock is ownership in a corporation and is represented by shares
which are a percentage of the company’s assets and earnings
(Morgenson & Harvey, 2002). Corporations issue stock in order
to finance large expenditures with a lower risk than assuming the total responsibility for the expenditure. Investors buy
stock for long term investment potential and short term income
from dividends (Groz, 1999). For some investors, the idea of
owning a piece of a company – especially an important, large
and established one with a good reputation is also an investment
that feels good. Investors looking for opportunities may wish
for stock splits or look into stock options. But as with much of
the financial investing landscape neither are sure things. A stock
split occurs when a company decides to issue a 2 for 1 offer for
their shares giving investors twice as many shares as when they
started. However, the shares are now worth half the price. The
idea for making money in financial markets with stock splits is to
drive up the price of the newly split stock to increase the value.
Stock options are the “chance to buy a … stock at a future date at
a certain price” (Kansas, 2005). If the option is worth more at the
end of a “vesting” period than the investor is better off.
Essay by Marlanda English, Ph. D.
Bonds
Another investment opportunity that is even larger than the stock
market is the bond market. Bonds are a form of debt issued for
more than a year and allow companies and governments to raise
money (Morgenson & Harvey, 2002). The bond yields a return
on investment called interest that is paid to the holder once it
is redeemed. The United States government is a big seller of
bonds and was often able to use the idea of investing in yourself
and patriotism as a reason for buying bonds. Not only would
the investor get a good return but could feel good about helping
the country. Treasury bonds help the U.S. government function
because not enough is raised in taxes (Kansas, 2005). Bonds are
considered to be less interesting than stocks but are considered
safe because Treasury bonds are backed by the U.S. Government. The U.S. Government sells bonds at auction to foreign and
domestic financial institutions. Individuals can also purchase
bonds directly from the government. (Kansas, 2005).
Municipal Bonds are bonds that are issued by city, county and
state governments. These bonds pay higher yields than treasury
bonds and have tax advantages for investors. Because of the
focus on the stock market, many may forget the bond market
and not consider the many players that operate including companies, government, individuals and financial institutions. Bond
markets have ratings agencies that determine the credit worthiness of the entities that issue bonds. Two major ratings agencies
are Moody’s Investors Service and Standard and Poor’s (Kansas,
2005). These agencies study the bond issuers in terms of how
they repay and what their financial status is in order to rate them
as credit risks and ultimately use their issued bonds as investments.
Market Regulations
There are rules and procedures that govern how financial markets work. In addition, there are regulators who maintain control
so that markets can operate fairly. Important rules for investors
include knowing how various players are regulated and what
their rights are as investors (Groz, 1999). Hood & Taylor (1992)
discussed the many changes that force restructuring of the
financial services industry and explained what regulation control banks offer as services and how those services are offered.
There are a number of regulations that banks have to adhere to
including “Equal Credit Opportunity Act, the Home Mortgage
Disclosure Act, the Truth-in-Lending Act, the Funds Availability
Act, the Real Estate Settlement Procedures Act, the Fair Housing
Act, the Bank Secrecy Act, the Community Reinvestment Act,
and various IRS and federal insurance regulations” (Hood &
Taylor, 1992). These regulations are usually complex and filled
with legal, government and financial jargon. Although regulations are supposed to protect consumers, the increased cost of
implementing them is usually passed on to the consumer by the
financial institution. Consumers may also face a reduction in service based on the institutions decision making regarding how to
balance regulatory cost.
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Financial Markets & Institutions
The American Banking Association (ABA) estimated a cost of
$19 million a year in 1991 to comply with regulations. Much of
the administrative paperwork can be alleviated by technology
but the cost of investing in and upgrading technology is expensive as well. Smaller institutions usually find the administrative
burden overwhelming and affiliation with or takeover by larger
institutions may look favorable (Hood & Taylor, 1992).
Insider trading is a constant attraction within financial markets as
the ‘insiders’ have information that if shared in a particular and
unethical way could cause the ‘insiders,’ and those they choose to
partner with, to prosper. Kansas (2005) felt illegal insider trading
thrives because of difficulties in enforcing it. Legal insider trading involves executives and managers in companies who trade
their own stocks and securities based on how they feel about
their company, industry and the market in general. This type
of trading is not illegal if the investor did not use what Kansas
(2005) calls “nonpublic” information. However, some watch the
trading habits of large investors with large chunks of specific
stocks to adjust their own actions.
The Strategy of Investing
Investors have many ways to get involved in investing and
to interact with financial markets and institutions. The sheer
number of alternatives presents yet another way that investors
can be paralyzed and overwhelmed by too much information
and too many choices. If an investor decides to invest in stocks,
some preparation and study must be done to decide how and
what to buy. The goals of the investor and the resources available
to the investor are important considerations when developing an
investment strategy.
Kansas (2005) noted that stock investments require investors
to consider: Valuation, strategy, diversification and appetite for
risk.
• Valuation is looking at the value of a stock based on the
underlying company’s assets, earnings, history and projected
market value.
• Strategy is the approach that the investor takes to achieve
investment objectives.
• Diversification is dividing investments among securities
with different risk and reward to minimize extensive and
untenable risk.
• Finally, the investor’s appetite for risk is a measure of how
much risk the investor can sustain short and long term (Morgenson & Harvey, 2002).
Bank Investments
Investors can choose to align themselves with specific players in the financial markets and pool all of their investments
with a player they trust. Some investors will place the bulk of
their investment funds with their local bank and only invest in
investments that are offered by the bank. These investments can
include savings and checking accounts, certificates of deposit,
Essay by Marlanda English, Ph. D.
and bonds. Often, if real estate is the selected investment, an
investor may decide to obtain mortgage loans through banks
where relationships exist.
Firm Investing
Other trusted players are often the investor’s employer who may
issue stock, offer employee stock purchase programs or recommend investment advisors. These options make it easy and
non-intimidating to participate in the financial markets. Mutual
funds offer a way to participate in the stock market without much
of the risk and are popular with individual investors. The use of
financial planners by securities firms can help make these institutions more accessible to individual investors. Financial planners
will often put a personal face on a big company and give the individual investor a feeling of security and continuity. According to
Kansas (2005) securities firms are also called brokerage firms
or investment banks and deal in stocks and bonds, primarily.
They include Merrill Lynch, Goldman Sachs and Morgan Stanley. These firms may also make the reports of research analysts
available to investors as part of the educational process.
Helpful Information for Investors
Regular information and data is released for public consumption
regarding the economy and information about government activity, jobs and employment data, as well as inflation and spending
indexes that can influence the strategy of the investor. A big part
of strategy that isn’t easily measured is gut-feel. Investors must
react to activity in the markets and make decisions based on
how they feel the market will trend. The Department of Commerce (DOC) issues an inflation gauge called the Consumer
Price Index (CPI) which measures consumer buying activity
for items that are purchased on a regular basis. The DOC also
measures the Producers Price Index (PPI) which is a measure of
wholesale, business to business buying and selling. Changes in
the buying habits of consumers up or down can influence where
the economy is trending just as changes for businesses influence
what consumers are able to buy and at what price. The Treasury
Department issues the Gross Domestic Product (GDP) index
which tells the investor whether the economy is getting healthier, is staying the same or is becoming less robust. The Federal
Reserve oversees that banking system and manages the economy
by taking action based on what the indexes indicate about the
economy (Kansas, 2005).
Since most investors do not have direct contact with these governmental entities, their investment strategy will be driven by the
personal spin they put on what this information means. That can
be influenced by media coverage, information that the investor
tracks on a regular basis, conversations with others and advice
of financial advisors. In the end, the investor must enter the
financial markets and deal with financial institutions based on an
investment strategy that maximizes growth and minimizes risk.
A sound strategy will also provide for changes that are likely to
occur.
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Financial Markets & Institutions
Viewpoints
The Impact of the Financial Services Industry
The financial services industry has significant impact on the life
and health of the general economy. In Illinois, a state court judge
ordered the state government to stop using money in funds to
finance financial institutions for general government expenses
(Credit Union Journal, 2005). The stability of banks, credit
unions and savings and loans could be damaged if state legislatures attempt to fill holes in their budgets by accessing safety
net funds. If these institutions were to fail, panic could ensue and
jeopardize depositor savings.
Because the flow of money is so important to the stability and
growth of a nation, the financial services industry has been a
prime target of terrorists. To disrupt the flow and exchange of
money would disturb the entire economy on a temporary and
possibly a long term basis. The U.S. Treasury has developed
procedures by which financial institutions can exchange information about financial transactions and possible money laundering
by terrorists (Kite, 2002). The new procedures mean a greater
reporting burden for financial managers. Additions to these regulations prescribe how information about transactions and money
laundering should be shared with law enforcement.
Financial institutions engage in measurement of a customer’s
profitability to the institution. The profitability from customers
is invested in capital and equipment projects and used to cover
risks of investments. Institutions also look at the profitability of
customers to see how well portfolio managers perform (Weiner,
2000/2001).
Opportunities in the Financial Services Industry
The opportunities for employment in the financial services
industry are great. People involved in financial services include
commercial and personal bankers, mortgage counselors, financial advisors and investment bankers, economists, actuaries and
securities traders. According to the Bureau of Labor Statistics
(ww.bls.gov) the banking industry shows a slight decline in
pay and employment as consumers move their investments to
higher yielding products with investment firms and others. The
BLS noted “The banking industry employed about 1.8 million
wage and salary workers in 2004. About 7 out of 10 jobs were
in commercial banks; the remainder … concentrated in savings
institutions and credit unions.” In 2004, there were 355,000
financial analysts and personal financial advisors. This group is
expected to have better than average growth through 2014. Many
financial services industry jobs require advanced education and
some even require certification if the individual is engaging in
certain types of securities or other sales. The securities industry
employed 767,000 people in 2004 and is expected to see a 16%
increase in growth by 2014.
While many of the jobs in financial services ‘sound’ financial, there are also opportunities in compliance and regulatory
enforcement for government entities and others. Some have
titles such as financial examiners and investigators or less obvi-
Essay by Marlanda English, Ph. D.
ous ones. The impact of financial institutions on other industries
will bring others into the financial services arena of opportunity. For example, healthcare is exploding because of the aging
population and people living longer. Consumer directed healthcare where people individually control their care is causing a
convergence of financial institutions which understand how to
charge for services electronically. Governments are also looking
for people with advanced financial skills because many governments are facing unprecedented financial issues and need higher
quality solutions to address them. Investors are also looking for
more information and control making information technology
companies natural partners for financial ones and indicating a
continued convergence of the two.
Terms & Concepts
Bond: Information that managers use to determine performance
of information technology systems and return on investment.
Equity: Ownership in an asset or a company. It is also another
name for the value in a real estate property or for shares of
stock.
Financial Market: A market for buyers and sellers of financial
securities.
Financial Institutions: Organizations engaged in financial
transactions.
Mutual Funds: Pools of funds managed by an investment company.
Security: A document that provides proof of ownership of a
stock, bond or other investment.
Stock: Usually refers to the lowest level of management dealing
with day-to-day or operational issues.
Bibliography
Bureau of Labor Statistics. (2006). Industry at a glance: financial services supersector. Retrieved September 16, 2007,
from http://www.bls.gov/iag/financial.htm.
Groz, M. M. (1999). Forbes guide to the markets: becoming a
savvy investor. New York: John Wiley and Sons.
Hood, J. & Taylor, J.A. (1992). Consumers bear costs of banking regs. Consumers’ Research Magazine, 75(10), 21-24.
Retrieved May 19, 2007, from EBSCO Online Database
Business Source Complete. http://search.ebscohost.com/
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host-live
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Financial Markets & Institutions
Kansas, D. (2005). The Wall Street Journal: complete money &
investing guidebook. New York: Three Rivers Press.
Kite, S. (2002). Treasury adds secure network to battle terrorism. Securities Industry News, 14(6), 23. Retrieved
September 16, 2007, from EBSCO Online Database
Business Source Complete. http://search.ebscohost.com/
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Morgenson, G. & Harvey, C. R. (2002). The New York Times
Dictionary of Money Investing. New York: Times Books.
The Credit Union Journal daily. (2005). Credit Union Journal,
9(11), 17. Retrieved September 16, 2007, from EBSCO
Online Database Business Source Complete. http://search.
ebscohost.com/login.aspx?direct=true&db=bth&AN=1649
2306&site=bsi-live
Weiner, J. (2000/2001). Return on capital: The primary measure of customer value. Bank Accounting & Finance,
14(2), 15-20. Retrieved September 16, 2007, from EBSCO
Online Database Business Source Complete. http://search.
ebscohost.com/login.aspx?direct=true&db=bth&AN=4095
646&site=bsi-live
Essay by Marlanda English, Ph. D.
Suggested Reading
Kirchhoff, S., Waggoner, J. and Hagenbaugh, B. (2007).
Spirits, markets get a lift. USA Today, Retrieved
September 21, 2007 from EBSCO Online Database
Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=
J0E405562471807&site=ehost-live.
Long-term market views unchanged by credit crisis. (2007).
Emerging Europe Monitor: Russia & CIS, 11(10), 3.
Retrieved September 21, 2007, from EBSCO Online
Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26551309
&site=bsi-live
Socorro, M. P. (2007). Mergers under certainty; the effects
of debt financing. Manchester School, 75(5), 580-597.
Retrieved September 21, 2007, from EBSCO Online
Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=26225119
&site=ehost-live
Essay by Marlanda English, Ph. D.
Dr. Marlanda English is president of ECS Consulting Associates which provides executive coaching and management consulting
services. ECS also provides online professional development content. Dr. English was previously employed in various engineering,
marketing and management positions with IBM, American Airlines, Borg-Warner Automotive and Johnson & Johnson. Dr. English
holds a doctorate in business with a major in organization and management and a specialization in e-business.
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