Basic Concepts about Financial Market

Definition

Market: Market is an institution set up by society to allocate

resources that are scarce relative to the demand for them. Markets are the channel 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./ Or

Forums in 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.

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 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 insurance policies.

g.) Finally, 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.

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.

Financial Institutions and Fund Transfer system

2. Through an Investment Banking House fund also transfers among different sectors. In this case it serves as a middleman and facilitates the issuance of securities.

3. Transfer can also be made through a Financial Intermediary such as a bank or

a mutual fund.

Classifications of Financial Markets

Two major Financial Markets are-1. 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 to finance the government which maturity normally 91 days to 1 year.

Repurchase agreements- Used by bank 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.

Classification of Capital Market

Primary Market: The primary market is for the trading of new securities never before issued. Its principal function is raising financial capital to support new investment in buildings, equipment, and inventories. Investors engage in a primary-market transaction when they purchase shares of stock just issued by a company or borrow through a new mortgage to purchase a home.

Classification of Capital Market

Secondary Market: The secondary market deals in securities previously issued. Its chief function is to provide liquidity to security investors- that 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.

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 realizing increases in share price.

The Capital Market Instruments:

Preferred Stock- A special form of ownership having a fixed periodic dividend that must be paid prior to payment of any common stock dividends.

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.

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.

Some Other Types of Market

Mortgage Markets deal with loans on residential, commercial and industrial real estate, and on farmland.

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 on an organized exchange, it is customary to say it is traded over the counter. The over the counter market is an intangible organization that

consists of a network of brokers and dealers around the country.

Securities ExchangeSecurities 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 are the New York Stock Exchange (NYSE) and the American Stock Exchange (AMEX), both headquartered in New York City. In our country : DSE and CSE

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

determines and publicizes prices.

DSE

Established- 28th April 1954 as East Pakistan Stock Exchange Association.

Re-named- 23rd June 1962 as ‘The Dhaka Stock Exchange Limited’.

Registered as a public limited company and its activities are regulated by its Articles of Association, own rules and regulations, Securities and Exchange Commission Act1993, Company Act 1994

Main Activities of DSE

i. Listing of Companies (as per listing regulations)

ii. Providing the screen based automated trading for listed securities.

iii. Monitoring the activities of listed firms.iv. Market administration and controll.v. Market surveillancevi. Publication of monthly review.vii. Annoncement of price sensitive or other

information.

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.

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.

3. Strong from efficiency- which implies that all information, whether public or private, is fully

reflected in a security’s price.