Basic Concepts about Financial
Market
Market:
Market is an institution set up by society to allocate
resources that are scarce relative to the demand for
them. Markets are the channels or mechanism through
which buyers and sellers meet to exchange goods,
services and productive resources.
Financial Markets:
We usually describe the financial markets as being a
system comprised of individuals and institutions,
instruments, and procedures that bring together
borrowers and severs, no matter the location. It is a
forum by which suppliers of funds and demanders of
fund can transact business directly.
Functions Performed by Financial
Market
a) Savings Function – Bonds, stocks and other
financial claims sold in the money and capital
markets provide a profitable, relatively low-risk
outlet for the public’s savings, which flow
through the financial markets into investment
so that more goods and services can be
produced (i.e., productivity will rise), increasing
the world’s standard of living. The financial
market enabled us to consume amounts
different than our current incomes. In other
word it allows us to transfer income through
time by either saving or borrowing.
Functions Performed by Financial
Market
b) Wealth Function – For those businesses and
individuals choosing to save, the financial instruments
sold in the money and capital markets provide an
excellent way to store wealth until funds are needed
for spending.
c) Liquidity Function – For wealth stored in financial
instruments, the global financial marketplace provides
a means of converting those instruments into cash
with little risk of loss. Thus, the world’s financial
markets provide liquidity for savers who hold financial
instruments but are in need of money.
Functions Performed by Financial
Market
d) Credit Function – Financial markets furnish credit
to finance consumption and investment spending.
Credit consists of a loan of funds in return for a
promise of future payment. Consumers, Businesses,
and Governments need credit for several reasons.
e) Payments Function – Financial markets also
provide a mechanism for making payments for goods
and services. Certain financial assets, bank checking
account, payment order, demand draft, plastic credit
card, ATM card and some other instruments serve as a
medium of exchange in making payments.
Functions Performed by Financial
Market
f) Risk Protection Function – The financial markets
around the world offer businesses, consumers, and
governments protection against life, health, property and
income risks. This is accomplishing, first of all, by the sale
of different types of insurance policies.
g) Economic Stabilization: in recent decades, the
financial markets have been the principal channel through
which government has carried out its policy of attempting
to stabilize the economy and avoid inflation. By
manipulating interest rates and the availability of credit,
government can affect the borrowing and spending plans
of the public, which in turn, influence the growth of jobs,
production and policies.
Classifications of Financial
Markets
Two major Financial Markets are1. The Money Market:
The money market is created by a financial
relationship between suppliers and
demanders of short-term funds (funds with
maturities of one year or less).
2. The Capital Market:
A market that enables suppliers and
demanders of long-term funds to make
transactions. Included are securities issues of
business and government.
The Money Market Instruments


Treasury Bill- Sold to institutional investors by
the Treasury (in BD it is the Treasury of
Bangladesh Bank) to finance the government’s
short term requirements for which maturity
normally last from 91 days to 1 year.
Repurchase Agreements- Used by banks to
adjust reserves. Here banks sell investments
with repurchase promise for very short time.
The Money Market Instruments



Bankers’ Acceptances- Firm’s promise to
pay; guaranteed by a bank. Usually low
degree of risk involved here if bank is strong
and reputed.
Negotiable Certificates of Deposits
(CDs)- Issued by major money-center
commercial banks to large investors. This
instrument is riskier than Treasury bills.
Commercial Paper- Issued by large,
financially secure firms to large investors. It
has law default risk.
The Capital Market Instruments:


Corporate Bonds- Issued by corporations to
individuals, institutional investors, and corporations.
Risk depends on the company and normally riskier
than government bonds, but not as risky as stock.
Example, IBBL public bond.
Preferred Stock- A special form of ownership having
a fixed periodic dividend that must be paid prior to
payment of any common stock dividends. In
Bangladesh companies are not allowed to offer
preferred stock.
The Capital Market Instruments

Common Stock- Units of ownership, or
equity in a corporation. It is issued by
corporations to individuals and
institutional investors. Common stock
holders earn a return by receiving
dividends or by capital gain through
realizing increases in share price.
Classification of Capital Market

Primary Market: The primary market is for
the trading of new securities never issued
before. Its principal function is raising financial
capital to support new investment in buildings,
equipment, and inventories or even to pay off
the previous debts. Investors engage in a
primary-market transaction when they purchase
shares of stock just issued by a company.
Classification of Capital Market

Secondary Market: The secondary market deals in
securities issued previously. The proceeds from any
share sold in the secondary market does not go to the
corporations directly. But it creates a market for the
sellers to trade their ownerships. Thus, its chief
function is to provide liquidity to security investorsthat is, provide an avenue for converting financial
instruments into ready cash. The volume of trading in
the secondary market is far larger than the primary
market.
Security Exchange

Securities Exchange –
Organizations that provide the marketplace in
which firms can raise funds through the sale
of new securities and purchasers can resell
securities. The best-known organized
exchanges in the world include the New York
Stock Exchange (NYSE), the American Stock
Exchange (AMEX), the London Stock
Exchange, the Hong Kong Stock Exchange,
and the Singapore Stock Exchange.
Some Other Types of Market
Debt Markets are the markets where loans
are traded. In this case debt instruments are
necessary for trading which represent as a
contract that specifies the amounts, as well as
the times, a borrower must repay the funds
provided by lender. The borrower can be an
individual, a government or a business.
Mortgage Markets deal with loans on
residential, commercial and industrial real
estate, and on farmland.
Some Other Types of Market


Consumer Credit Markets involve loans on
autos and appliance, as well as loans for
education, vacation, marriage and so forth.
A Spot Market is one in which assets or
financial services are traded for immediate
delivery (usually within one or two business
days).
Some Other Types of Market


A Futures and Forward Market is designed
to trade contracts calling for the future delivery
of financial instruments.
Over the Counter Market: If a security is not
traded in an organized exchange, it is
customary to say it is traded over the counter
(OTC). The over the counter market is an
intangible organization that consists of a
network of brokers and dealers around the
country.
The Role of Securities
Exchanges:

Securities exchanges create continuous markets
in which firms can obtain needed financing.
They also create efficient markets that allocate
funds to their most productive uses. This is
especially true for securities that are actively
traded on major exchanges, where the
competition among wealth- maximizing
investors determine and publicize the prices.
Financial Institutions and Fund
Transfer system

1. A Direct Transfer of money and securities
occurs when a business sells its stocks or
bonds directly to savers (investors), without
going through any type of financial institution.
In Bangladesh, government owned oil and gas
companies went directly to the share market
without going through any financial institutions
as guarantors.
Financial Institutions and Fund
Transfer system
2. Through an Investment Banking House
funds are also transferred among different
sectors. In this case they serve as an
intermediaries or middlemen and facilitate the
issuance of securities.
3. Transfer can also be made through other
Financial Intermediaries such as a bank or a
mutual fund.
Capital Market Efficiency
 An
efficient capital market is one in
which the prices of securities “fully
reflect” all available information.
The reflection or reaction of market
prices to new information should be
instantaneous and unbiased.
Efficient Capital Market (Cont.)

A market which truly reflects the demand
and supply equilibrium price of the stocks.
S
share
price
D
O
Number of Share Traded
Types of
Capital Market Efficiency
1.
Weak form efficiency- which implies that the
information contained in the past sequence of
prices of a security is fully reflected in the current
price of that security.
2. Semi-strong form efficiency- which implies that all
publicly available information is fully reflected a
security’s market price, including information
about past prices and volume.
Types of
Capital Market Efficiency
3. Strong from efficiency- which
implies that all information, whether
public or private, is fully reflected in
a security’s price.