Financial Market
What Does Financial Market Mean?
Some financial markets only allow participants that meet certain criteria, which can be based on factors like the amount of money held, the investor’s geographical location, knowledge of the markets or the profession of the participant.
Financial Market
Financial markets can be found in nearly every nation in the world. Some are very small, with only a few participants, while others – like the New York Stock Exchange (NYSE) and the forex markets – trade trillions of dollars daily.
Most financial markets have periods of heavy trading and demand for securities; in these periods, prices may rise above historical norms. The converse is also true – downturns may cause prices to fall past levels of intrinsic value, based on low levels of demand or other macroeconomic forces like tax rates, national production or employment levels.
Information transparency is important to increase the confidence of participants and therefore foster an efficient financial marketplace.
References:
Financial markets can be found in nearly every nation in the world. Some are very small, with only a few participants, while others – like the New York Stock Exchange (NYSE) and the forex markets – trade trillions of dollars daily.
Most financial markets have periods of heavy trading and demand for securities; in these periods, prices may rise above historical norms. The converse is also true – downturns may cause prices to fall past levels of intrinsic value, based on low levels of demand or other macroeconomic forces like tax rates, national production or employment levels.
Information transparency is important to increase the confidence of participants and therefore foster an efficient financial marketplace.
The Financial Market is a systematic structure that allows people to buy and sell (trade) financial securities (such as stocks and bonds), commodities (such as precious metals or agricultural goods), and other fungible items of value at low transaction costs and at prices that reflect the efficient-market hypothesis.
Financial Markets facilitate the raising of capital (from the capital markets), the transfer of risk (in the derivatives markets), international trade (in the currency markets); and are used to bridge those participants who need capital with those who have funds to invest.
Generally a borrower issues a receipt to the lender, promising to pay back the capital. These receipts are securities which may be freely bought or sold. In return for lending money to the borrower, the lender will expect some compensation in the form of interest or dividends [1].
A Capital Market is a market for securities (debt, equity etc.), where companies and governments can raise long-term funds. It is defined as a market in which money is provided for periods longer than a year, as the raising of short-term funds takes place on other markets (e.g., the money market). The Capital Market includes the stock market (equity securities) and the bond market (debt). There are financial regulators globally who oversee the Capital Markets in their designated legal jurisdictions to ensure that investors are protected against fraud, and among other duties.
Capital Markets may be classified as primary markets and secondary markets. In primary markets, new stock or bond issues are sold to investors via a mechanism known as underwriting. In the secondary markets, existing securities are sold and bought among investors or traders, usually on a securities exchange, over-the-counter, or elsewhere [2].
Capital Market Participants | ||||||||
Investment Banks | Commercial Banks | Exchanges | Supranational Banks | Central Banks | Rating Agencies | Regulators | Others | |
• Credit Suisse | • Bank of America | • NYSE | • World Bank | • Bank of England | • S&P | • SEC | ||
• JP Morgan | • Citi Bank | • Nasdaq | • IMF | • BCB (Brazil) | • Moody's | • FED | ||
• Goldman Sachs | • Wells Fargo | • CME | • Asia Development Bank | • RBI (India) | • Fitch | • FSA(UK) • CFTC | ||
• UBS | • RBS | • LSE | etc. | etc. | etc. | • FSA(Japan) | ||
• DB | • Lloyds | • SSE | • CIRC(China) | |||||
• BNP Paribas | • Société Générale | • SIX Swiss Exchange | • CSRC(China) | |||||
etc. | • ICBC etc. | • CSE etc. | etc. | |||||
Market Place | ||||||||
Trading Location | Fixed Income | Equity | Commodities | Currency | Derivatives | Futures and Options | Others | |
Bonds, RMBS, Convertible, CMBS, CDO, etc. | Stocks, Equity-related securities, Preferred stocks, etc. | Oil, Power, Gas, Grains, Metals, Precious metals, etc. | CHF, GBP, Euro, USD, Yuan, etc. | Structured Derivatives, Fixed Income, Equity, etc. | Commodities, FX, Int. Rate, Equity, etc. | |||
(New Issue and Trading) | (IPO and Trading) | (Trading) | (Trading) | (Trading) | (Trading) | |||
• Exchanges | Y | Y | Y | Y | - | Y | ||
• Over The Counter | Y | Y | Y | Y | Y | Y | ||
• Internet | Y | Y | Y | Y | - | Y | ||
• Other(?) | ||||||||
Y = Yes; ‘-‘= No | ||||||||
1.1.1. Bonds, Fixed Income:
A bond is a debt instrument requiring the issuer (also called debtor or borrower) to repay to the lender or investor the amount borrowed plus interest over some specific period of time [3].
1.1.2. Equities
Equity investments generally refers to the buying and holding of shares or stocks on a stock market by individuals and firms in anticipation of income from dividends and capital gain as the value of the stock rises. It also sometimes refers to the acquisition of equity (ownership) participation in a private company or a startup. When the investment is in start-up companies, it is referred to as venture capital investing and is generally understood to be higher risk than investment in listed going-concern situations.
IPO: An initial public offering (IPO) referred to as an "offering" or "flotation," is when first time a company or issuer issues common stock or shares to the public. They are often issued by smaller, newer companies seeking capital to expand their business, but can also be done by large privately-owned companies looking to become publicly traded.
Prospectus: A formal legal document, which is filed with the Securities and Exchange Commission, which provides details about an investment offering for sale to the public. A prospectus should contain the facts and information that an investor needs to make a well informed investment decision.
Book building: It refers to the process of generating, capturing, and recording investor’s demand for shares during an IPO (or other securities, bonds during their issuance process) in order to support efficient price discovery.
Bookrunner: A bookrunner is usually the main underwriter or lead-manager in equity, debt, or hybrid securities issuances. The bookrunner usually synchronizes with other Investment Banks in order to lower its risk.
1.1.3. Commodities
Commodities are a wide range of products like wheat, corn, timber, copper, gold, silver, natural gas, oil etc. The trading of commodities consists of direct physical trading and derivatives trading. The commodities markets have seen an upturn in the volume of trading in recent years. In the five years up to 2007, the value of global physical exports of commodities increased by 17% while the notional value outstanding of commodity OTC derivatives increased more than 500% and commodity derivative trading on exchanges more than 200%. The notional value outstanding of banks' commodities’ OTC derivatives contracts (based on the 'Bank for International Settlements' interpretation of commodity derivatives) increased 27% in 2007 to $9.0 trillion. The large increase in trading over the last few years was due to a rise in trading in non-precious metals and oil and natural gas as energy prices rose. Average daily commissions in OTC energy products on ICE rose 39% in 2007, representing the fourth consecutive year of record commissions. Energy derivatives covering power and gas forward contracts in the OTC derivatives markets have also grown in recent years (more on this can be found in IFSL’s Derivatives report). Trading on exchanges in China and India has gained in importance in recent years due to their emergence as significant commodities consumers and producers. [4]
1.1.4. Foreign Exchange
The foreign exchange market (forex, FX, or currency market) is a worldwide decentralized over-the-counter Financial Market for the trading of currencies. Financial centers around the world function as anchors of trading between a wide range of different types of buyers and sellers around the clock, with the exception of weekends. The foreign exchange market determines the relative value of different currencies.[5] In the Forex market, volumes traded are many multiples of the actual physical trade volume.
1.1.5. Over-the-Counter (OTC) Derivatives
Structured derivatives are always made up of a combination of one or more traditional asset classes and a derivative instrument (for example an option). The spectrum of potential underlying instruments (underlying) is wide, encompassing interest rates, equities, currencies, commodities, and indices, among others. Combining a traditional investment with derivatives gives rise to a new financial product that can cover a wide range of needs or be combined with other such characteristics of products like protection of invested capital, optimization of return, flexibility, diversification of risk [6].
1.1.6. Exchange Traded Futures and Options
A futures contract is a standardized contract between two parties to buy or sell a specified asset of standardized quantity and quality at a specified future date at a price agreed on the day of transaction (the futures price). The contracts are traded on a futures exchange. Futures contracts are not "direct" securities like stocks, bonds, rights or warrants. They are still securities, however, though they are a type of derivative contract. [7]
Options are a type of financial instrument classed as derivatives, as they 'derive' their value from an underlying asset. An option gives its holder the right, but not the obligation, to buy (call option) or to sell (put option) some underlying asset on or before the option's expiration date at an agreed on price (the strike price). [8]
Lots of companies hedge their major input costs to manage their operational cost and to increase profits. For an example, airlines hedge jet fuel costs. Similarly, real estate and house building companies hedge timber to maximize profit and reduce the cost of building houses. For example, in 2008 Southwest had 70% of its fuel needs hedged at $51 per barrel, while most other major airlines had only between 20% and 30% of their fuel hedged at an average $100 per barrel. [9] Because of its hedges, Southwest maintained an industry-leading [10] average price of $2.44 per gallon of jet fuel in 2008. [11] For the first nine months of 2009, Southwest paid an average of $2.07 per gallon, about 15% less than its average cost per gallon during the first nine months of 2008.[12]This helps Southwest to make more profits compared to peer companies.
1.1.7. Others
TBD
1.2.1. Investment Banks
An Investment Bank is a financial institution that assists corporations and governments in raising capital by underwriting or acting as the agent in the issuance of securities. An Investment Bank also involves in activities like securities trading, corporate finance, and asset and wealth management. It provides services such as market making and the trading of derivatives, fixed income instruments, foreign exchange, commodity, equity securities, prime brokerage, equity issuance research, and M&A advisory.
1.2.2. Commercial Banks
Commercial Banking is also known as business banking. It is a bank that provides checking accounts, savings accounts, and money market accounts and that accepts fixed time deposits.
1.2.3. Merchant Banks
A Merchant Bank is a financial institution primarily engaged in offering financial services and advice to corporations and to wealthy, high net-worth individuals. The major difference with an Investment Bank is that a Merchant Bank invests its own capital in a client company whereas an Investment Bank distributes and trades the securities of that company in its capital raising role. Merchant Bank deals mostly in international finance, long-term loans for companies and underwriting. Merchant Banks do not provide regular banking services to the general public.
1.2.4. Exchanges
An exchange is a highly organized market where tradable securities, commodities, foreign exchange, futures, and options contracts are sold and bought. Exchanges bring together brokers and dealers who buy and sell these objects. These various financial instruments can typically be sold either through the exchange, typically with the benefit of a clearinghouse to cover defaults, or over-the-counter, where there is typically less protection against counterparty risk from clearinghouses [13] although OTC clearinghouses have become more common over the years, with regulators placing pressure on the OTC markets to clear and display trades openly. [14][15]
1.2.5. Supranational Banks
Supranational Banks are global banking organizations, which are not regulated by any specific country laws and legislation. Therefore they act as very powerful governing bodies for the worldwide financial system e.g. IMF, World Bank, Asia Development Bank etc.
1.2.6. Central Banks
Central Bank is a nation's principal monetary authority, which regulates the money supply and credit, issues currency, and manages the rate of exchange, holds the reserves of nation's other banks and sells new issues of securities for the government.
1.2.7. Rating Agencies
A credit rating agency is an organization that assigns credit ratings for issuers of certain types of debt obligations as well as the financial debt instruments themselves. Ratings agencies have been criticized heavily by many for their role in the U.S. financial crisis, in particular over conflicts of interest and their failure to recognize the high risks inherent in complex structured products. They have also been blamed for throwing fuel onto the fire of crises by belatedly and aggressively ratcheting down ratings. Numerous proposals have been put forward to reform the rating process to avoid these issues [16]. Credit rating agencies are now under scrutiny for giving investment-grade, "money safe" ratings to securitization transactions (CDOs and MBSs) based on subprime mortgage loans. These high ratings encouraged a flow of global investor funds into these securities, funding the housing bubble in the U.S.[17]
1.2.8. Regulators
Financial regulators are needed to regulate and supervise financial institutions to certain standards, restrictions and guidelines, and to maintain the integrity of the financial system. Each country sets up multiple regulatory governing bodies. These financial regulators usually enforce applicable laws, prosecute cases of market misconduct, such as insider trading, provide license for financial services, protect clients, investigate complaints, and maintain confidence in the financial system. In the US regulators includes SEC, FED, CFTC, FDIC etc.
References:
1. Financial Market: http://en.wikipedia.org/wiki/Financial_market
2. Capital Market: http://en.wikipedia.org/wiki/Capital_market
4. Commodity
5. Derivative: http://en.wikipedia.org/wiki/Derivative_(finance)
6. Futures: http://en.wikipedia.org/wiki/Futures_contract
7. Options: http://en.wikipedia.org/wiki/Option_(finance)
8. Over-the-Counter Options. From About.com.
