FINANCIAL MARKETS (international)

1. CHAPTER THREE
FINANCIAL MARKETS

2. FINCIAL MARKETS
• A financial market is a market in which people trade financial securities and derivatives at low
transaction costs. they are called by different names, including “WALL STREET” and “capital market,”
but all of them still mean one and the same thing.
• Simply put, businesses and investors can go to financial markets to raise money to grow their
business and to make more money, respectively.
• To state it more clearly, let us imagine a bank where an individual maintains a savings account. The
bank can use their money and the money of other depositors to loan to other individuals and
organizations and charge an interest fee.
• The depositors themselves also earn and see their money grow through the interest that is paid to it.
Therefore, the bank serves as a financial market that benefits both the depositors and the debtors.

3. • The financial markets of many countries, where securities transactions take
place, are efficient and well organized, with a variety of institutions to help
capital flow throughout the economy.
• Until recently, virtually all financial markets had physical locations, such as in
New York or Chicago.
• With the advent of technological change, some are now computer or telephone
networks performing the same functions.
• The over-the-counter (OTC) market for stocks, National Association of Securities
Dealers Automated Quotation System (NASDAQ), and the foreign currency
markets that operate 24 hours a day are examples.

4. Primary and Secondary Markets
• Financial markets may be classified in one of two fundamental categories, primary and
secondary markets.
A. Primary and Secondary Markets
• These are markets that bring surplus savings units together with deficit savings units in the
process of financing productive activities. Securities are sold for the first time in primary
markets.
• When a company, for example, International Business Machines (IBM), wants to raise equity
capital, it issues securities in addition to those outstanding and now held by investors.
• It does this through a transaction in the primary markets, and the aggregate number and
value of securities in the economy increases. Thus, IBM thereby receives a capital infusion
for investment in presumably profitable projects that facilitate economic growth.

5. B. Secondary markets:
• These are markets in which already existing securities change hands. In effect, securities
are transferred from one surplus savings unit to another.
• Of course, in secondary-market transactions the firm that originally issued the securities
does not receive additional financing.
• Without strong secondary markets for existing securities, investors would be less inclined
to purchase them in the primary market in the first place (that is, less inclined to provide
corporate financing).
• Active secondary markets let investors buy or sell securities with minimal expense.
Secondary markets also give borrowing firms such as IBM (deficit savings units) valuable
information about market conditions for new issues of securities, including rates of return
that the market is likely to demand of a new issue.

6. Money and Capital Markets
• Beyond the primary-secondary market distinction, financial markets may be
classified in terms of the time to maturity of the securities traded.
• Short-term securities with 1 year or less to maturity are traded in money markets.
Money markets help investors and borrowers manage liquid assets that they do
not want to tie up for long periods.
• Treasury bills, commercial paper, and negotiable bank certificates of deposit are
examples of instruments that are traded in these markets.
• Long-term securities those with more than 1 year to maturity or with perpetual
life are traded in capital markets.

7. Types of Financial Markets
• There are so many financial markets, and every country is home to at least one, although
they vary in size. Some are small while some others are internationally known, such as the
New York stock exchange ( NYSE) that trades trillions of dollars on a daily basis.
Here are some types of financial markets.
1. Stock market
• The stock market trades (exchange) shares of ownership of public companies. Each share
comes with a price, and investors make money with the stocks when they perform well in
the market.
• It is easy to buy stocks. The real challenge is in choosing the right stocks that will earn
money for the investor.

8. 2. Bond market
• The bond market offers opportunities for companies and the government to
secure money to finance a project or investment.
• In a bond market, investors buy bonds from a company, and the company returns
the amount of the bonds within an agreed period, plus interest.
3. Over-the-Counter Markets
• An over-the-counter (OTC) market is a decentralized market—meaning it does not
have physical locations, and trading is conducted electronically—in which market
participants trade securities directly between two parties without a broker.

9. 3. Commodities market
• The commodities market is where traders and investors buy and sell natural resources or
commodities such as corn, oil, meat, and gold.
• A specific market is created for such resources because their price is unpredictable.
• There is a commodities futures market wherein the price of items that are to be
delivered at a given future time is already identified and sealed today.
4. Derivatives market
• Such a market involves derivatives or contracts whose value is based on the market
value of the asset being traded. The futures mentioned above in the commodities market
is an example of a derivative.

10. MONEY MARKET (INTERNATIONAL)
• Smoothly functioning financial markets allow financial institutions to
perform distribution and intermediation functions efficiently and
effectively.
• Financial markets are either money or capital markets, depending on
the maturity of the specific financial instruments that are traded.
• here we will discuss money markets, which are markets for short-
term loans
• The maturity of financial instruments that are traded is one way to
differentiate markets.
• If the securities traded are short-term instruments, the market is
called a money market. When maturities exceed 1 year, the market is
considered a capital market

11. • When T-bills are sold to the public for the first time, the sale takes place in a primary
money market.
• Investors buy or sell existing T -bills through dealers and these transactions occur in
secondary money markets.
• A complement in the capital market would be an initial public offering (IPO) of
common stock-a primary capital market transaction- while the subsequent exchange
of stock through stockbrokers occurs in the secondary capital market.
• Treasury bills are issued only in maturities of under 1 year, while common stock has
no maturity date, which makes common stock a long-term financial instrument.

12. • Money market: A market in which financial instruments matures up to 1 year are
bought and sold.
• Money markets enable market participants to borrow or lend liquid assets and
thereby meet needs for cash or investment of cash.
Liquid assets: These are assets that may be converted into cash quickly, without
significant loss of value.
• Investing excess liquid assets-that is, lending-reduces the opportunity cost of
holding cash or cash equivalents.
• Borrowing short-term funds eliminates disruption that would be caused by
temporary cash flow deficits.

14. MONEY MARKET PARTICIPANTS
The United States
The major money market participants are:
1. The Federal Reserve System
2. Government securities dealers
3. Commercial banks
• The U.S. Treasury issues the T-bills and other securities that are the foundation of
the money market.
• Short-term issues enable the government to raise money to meet necessary
expenditures between receipts of tax revenue.

15. • The Federal Reserve System historically holds over 75 percent of its financial
assets in the form of U.S. government securities, and its role in the operation
of money markets is a crucial one.
• The Federal Reserve (Fed) as the fiscal agent for the Treasury accepts bids for
and distributes all government securities in the primary market.
• If it appears that the money supply should be contracted to guard against
inflation, the Federal Reserve will enter the secondary money market and sell
government securities, increasing the amount of securities held by the private
sector and decreasing the money supply

16. • If the economy appears to need stimulation in the face of potential stagnation, the
Fed purchases securities, thereby increasing the money supply.
• The Federal Reserve frequently uses repurchase agreements (repos) and reverse
repos to effect these adjustments.
• Its ultimate responsibility for the money supply makes the Federal Reserve the
single most influential participant in U.S. money markets.
• Government securities dealers make markets in Treasury securities by buying large
blocks of securities from the Federal Reserve in the primary market and distributing
them to customers.
• commercial banks are major money market participants. Fractional reserve
requirements give commercial banks significant influence on the expansion and
contraction of the overall money supply whenever liquidity changes occur in the
economy.

17. MONEY MARKET INSTRUMENT
In the United States, the most widely traded money market instruments are:
I. U.S. Treasury bills
II. Federal funds
III. Repurchase agreements
IV. Negotiable certificates of deposit
V. Commercial paper
VI. Banker's acceptances
• Of the above list, the last three are traded in physical form, while the
remaining instruments are kept track of in book-entry form (electronic record
keeping) with written confirmations

18. characteristics of money market instruments
• Money market instruments share certain qualities that make them useful for
wholesale (large) transactions:
a. Liquidity, which describes the ability to convert an asset into cash with
relative ease while not significantly depressing its price in the process, is
perhaps the most important quality.
b. Default risk, which is the risk of nonpayment of principal or interest, must
be minimal in order for the security to be considered a safe haven for excess
liquidity.
c. Short time to maturity, given that adverse price movements attributable to
interest rate changes are smaller for shorter-term assets, helps ensure that
interest rate changes will not affect the security's market value materially.

19. Treasury Securities
• Treasury securities are obligations of the U.S. government.
• They are issued to cover government budget deficits (excess of expenditures over
revenues) and to refinance maturing government debt.
• The most common are bills, notes, and bonds.
Treasury bills have original maturities of 1 year or less.
Notes are for 1 to 10 years.
bonds have maturities greater than 10 years

20. Treasury bills (T-bills)
• This is short-term obligations of the U.S. Treasury Department with original
maturities of 1 year or less.
• Treasury bills and other Treasury securities with less than 1 year of remaining
life are the most important instruments in U.S. money markets.
T-bills in the Primary Market
• The Bidding Process of the Treasury Department auctions an announced
quantity of new bills each week through Federal Reserve district banks and
their branches.
• Bids may be submitted by government securities firms. Submitted bids are
either competitive or noncompetitive.

21. • Competitive bids specify the desired quantity of bills and the lowest interest rate
the buyer is willing to accept.
• Large investors usually submit competitive bids, which make up the bulk of the
aggregate dollar value of total bids.
• Treasury rules prohibit any single bidder from obtaining more than 35 percent of
any new issue.
• Noncompetitive bids are limited to $1 million or less and state only the quantity of
bills desired.
• A noncompetitive bidder accepts the weighted average interest rate of the winning
competitive bids. Historically, noncompetitive bids have constituted 10 to 25
percent of the total.
• An investor who submits a non-competitive bid agrees to accept the final discount
rate, which is determined by the competitive side of the auction.

22. T-Bill Pricing and Delivery
• Treasury bills are sold at a discount price.
Discount pricing:
• Setting the price of a financial instrument at the face value less the amount of interest
that will be earned through the maturity date.
• Interest earned is the difference between the price paid to purchase the instrument and
the amount received upon maturity.
• Treasury bill purchases are recorded in a book-entry system. Physical securities are never
delivered. Instead, a record of transactions is maintained electronically by the Treasury
and the Federal Reserve System.
• This arrangement significantly reduces transaction costs by eliminating the need to
handle, ship, or store physical documents.

23. T-bills in the Secondary Market
• In United States the secondary market in Treasury bills is a vast and
exceedingly efficient telecommunications network, whose major
participants are primary government securities dealers, approximately forty
financial institutions so designated by the Federal Reserve.
• These banks, brokerage firms, and bond houses buy and sell Treasury bills
for their own and their customers' accounts.
• Customers include depository institutions, insurance companies, pension
funds, non financial firms, and state and local governments.

24. • Government dealers help to maintain an orderly market mechanism
through trades of Treasury bills for their own accounts.
• They earn profits based on the difference between the price at which
they are willing to purchase Treasury bills, the bid price, and the price at
which they will sell them, the asked price.
Bid-asked spread
• Dealer profit in a T-bill transaction: the difference between the purchase
and sales prices that a dealer will accept.

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